Later this week the US Federal Reserve will make its long awaited announcement on its interest rate policy. The Fed will outline plans to either raise or maintain rates at 0.25%.
Whether the Fed hikes rates this month is still a matter of great debate. It’s split economists down the line.
I’ve maintained the Fed won’t raise rates until next year. Even prior to China’s shakeup of global markets, that was the likeliest outcome. But China’s economic slump has made near certain of that now.
The US won’t tighten credit at a time when China, and the world, goes in the opposite direction. Another key reason why the Fed might hold off for now is the Fed’s inflation targets.
Both headline and core inflation remains below 2%. At just 1.25%, inflation is below the point that could trigger monetary tightening.
Yet one thing is certain.
At some point in 2016 the Fed will kick start its rate policy reversal. It doesn’t matter whether rates go up this week, or next year. The outcome is the same.
Directly or indirectly, it will affect every market and investor around the world. From stocks, to property and cash. And knowing what’s on the horizon can help you plan your investments.
Let’s look at how rising US rates could impact your wealth in the future.
Rising interest rates and stock markets
Stock markets took a hammering over the last two months.
The Aussie share market shed 10% of its value in August. That came after Chinese stock markets wobbled, resulting in losses of trillions of dollars. The Shanghai Composite Index alone is down 2,000 points, from 5,200, since July.
Calling it market volatility is an understatement…
Yet China’s rout wasn’t the only thing weighing on global markets. Investor uncertainty over US interest rates was equally responsible. Which brings us where we are now.
If US interest rate speculation goes on, it could result in even more uncertainty — and volatility. Why? Because investors prefer the security of knowing. A rate rise may restore calm to markets. Keeping investors guessing for longer might be counterproductive. The Australian Financial Review reports:
‘A lot of people are saying they shouldn’t raise rates because there’s a lot of volatility in markets, [so] they should wait. But who’s to say by waiting the volatility will die down? It may get worse.
Let’s assume the Fed lifts interest rates this week. How would that affect your stock investments?
It won’t have a major effect, at least not initially. In the short term, it may even bring back some confidence. Stephen Halmarick, of Colonial First State explains:
‘If they do tighten this week, they’ll accompany the tightening with a pretty dovish statement emphasising how gradual the process is going to be’.
That’s reassuring if you’re a long-term investor. It means the effects of interest rate hikes on stocks would develop over time. That would lessen any immediate threat to the ASX.
There’s an upside too. An opportunity exists for investors with stocks in certain industries. The ones that benefit from a weaker Aussie dollar. Tourism, exports and financial sectors all win out from rising US rates.
Effects of interest rates on property investments
Rising US interest rates won’t affect the housing market immediately. But their longer-term effects on Aussie interest rates are important.
For property investors, the key is whether a US rate rise influences the RBA’s own rate policy. Rising US interest rates should ease pressure off the RBA lowering rates at home. A US rate hike strengthens the US dollar. Which weakens the Aussie dollar in turn. Which is the RBA’s ultimate goal. That would give the RBA less reason to lower interest rates.
In that case, housing demand would dampen. The investment market thrives on low rates. It looks to interest rate cuts to bolster investment growth. And it relies on strong demand to lift prices over time.
The outlook for both of these isn’t encouraging.
There are signs that housing demand is slowing. Median price growth across major capitals flatlined in August. Sydney, the best performer, saw prices rise just 1.1% during the month.
But owner-occupiers will also feel the effects. If housing demand slows, that hurts prices across the board. And households miss out on the benefit of lower rates on mortgage repayments.
Both owners and investors would prefer US rates remain on hold. That would increase the likelihood of Australia’s cash rate falling again soon.
In short, rising US interest rates would delay RBA’s own policy moves. This will only slow property price growth in Australia.
Interest rates hurt savers most
Low rates may benefit property investors. But they’re a nightmare for savers.
Record low interest rates in Australia affect savers more than anyone. Low interest rates mean small returns on savings and term deposits.
Like the property market, the effects of Fed hikes aren’t immediately obvious for Aussie savers.
Should the Fed lift rates this week, it would ease pressure on the RBA to follow suit.
But that’s not the only thing weighing on the RBA’s future decision. Unlike property prices, low rates hurt cash savings. If you have wealth tied up in cash, looking ahead the news is less positive. Why?
The biggest concern is the future of the Australian economy.
GDP growth could flatten in the third quarter, or worse. If Q3 growth falls below 0.2%, it would leave the economy in recession. You can bet a rate cut would follow shortly after. Possibly as early as November.
For savers, it’d be another punishment following a decade of falling interest rates.
The only way savers benefit is if interest rates increase. But lifting rates isn’t an option for Australia. And it won’t be anytime soon. That leaves a short to medium term future in which returns on cash remain low.
The only respite for savers is for US interest rates to rise. But that’s all it’d be, a breather. It won’t be long before the RBA slashes rates again. Whether that’s because of the Fed, or the Aussie economy, is only a matter of timing.
One way or another, US interest rates will rise over the next year. How far, and fast, they do will dictate how markets and central banks react. But the path ahead is clear.
Rising US interest rates will delay any RBA cuts. But if the US Fed doesn’t raise rates, then Australia’s economic slowdown could force the RBA’s hand. That’s good news for real estate and stocks, but less so for cash investments.
In a few short days we’ll have a better picture for where things are heading. You’re probably leaning one way or another depending on where your investments lie.
Contributor, The Daily Reckoning
PS: The Reserve Bank held interest rates at 2% in its September meeting. But if the economy doesn’t improve soon, it won’t have any choice in the matter.
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