Interest rates are rising as the Fed is trying to halt inflation in the US, but the US is considered a significant force in the world. So, usually, when the Federal Reserve (Fed) decides to raise interest rates, these rates often travel all over the globe, followed by other economic governing bodies. But how exactly is interest affecting the markets?
Interest rates as a tamper for inflation Raising interest rates makes it more difficult for money to circulate in the economy, making it harder for companies to take out loans for their business and harder for consumers to borrow money. Difficulties in loan creation eventually lead to decreased consumer spending, which reduces inflation because demand falls drastically.
Why are US interest rates such an important benchmark globally? When interest hikes occur in the US, the global economy seems to be affected widely, and interest rates seem to change globally following US decisions on interest rates. The US dollar is seen as a global reserve currency, meaning it is central to the worldwide economy as a means of payment and as a reserve currency. Therefore, a subtle change in supply and credit from raising interest rates can affect the cost of capital globally. In addition, treasury bills in the US seem to be the lowest risk investment. The risk-free rate is a rate of return on a treasury in which there is no danger of loss. Typically, the risk-free rate is either the existing Treasury Bill (or T-bill) rate or the return on a long-term government bond. Professionals deem T-bills nearly free of default risk since the United States government backs them fully.
Why do rising interest rates affect consumer spending? Rising interest affects the entire economy. Interest allows borrowers to spend their money on an immediate basis. When interest increases, it is generally more difficult for consumers to spend money directly, creating a lower spending rate. As a result, companies make less money, cutting their profits and forcing them to lay off some employees and save where necessary. A slowdown in the economy can lead to more caution among consumers and the federal reserve is always trying to make sure the economy can handle a rise in interest rates.
Sometimes, higher interest rates are necessary because ‘easy money,’ in the long term, is terrible for the economy. Easy money refers to a circumstance where the money supply and monetary policy enables cash to accumulate within the banking system as a result of the Fed reducing interest rates to make it easier for banks and lenders to lend money to the public, which causes inflationary issues due to extremely high demand.
What is the Federal Reserve’s plan? The Federal Reserve knows that the global markets hate surprises and will most likely try to be as transparent as possible when tapering and raising the interest rates in the US. The Fed has announced that short-term, they’re looking to increase interest rates even further this year, with the forecast totaling close to 2 percent by the end of 2022.
What is coming for global markets? During rising interest rates, inflationary issues and supply chain disruptions, the Federal Reserve will remain cautious in its actions. Higher interest rates make it more difficult for companies to borrow money to grow their business. Due to lower consumer spending, results will also naturally fall. It is important to note that financial companies often do particularly well during an economic downturn. Investing in stable companies with reasonable valuations that can generate profit and preferably pay-out dividends steadily is recommended.