Let's Talk About Interest Rates

Most of you will be familiar with the words "Interest Rates". But, is it as simple as what it may seem to be? Clearly not. You may be familiar with the concept that when a country is concerned about growth, the Central Bank of the country will decrease the Interest Rates of the country so as to promote greater consumption, investments and government spendings. The same goes opposite when a country is concerned about Inflation. A higher Interest Rate means higher borrowing cost and hence, lower consumption as people would tend to cut down on credit purchases. At the same time, a higher Interest Rate means more incentive to save. This in return will hope to slow down the economy and to counter Inflation. Hence for today, I would like to bring your attention to the happening in the United States regarding Interest Rates.

"Federal Reserve puts rate rise on hold"- Guardian

"Dovish Tone of Fed’s Monetary Policy Statement Surprises Economists"- New York Times

So what's the big deal of just increasing the US Interest Rates? Hasn't they been increasing and decreasing the Interest Rates all along? No, they didn't. In fact, the US Interest Rates has been left stagnant at a level of 0%-0.25% for near 7-8 years since the collapse of the the economy in 2007. This was done so to create higher consumption and also the recovery of the economy. In my view, the very action of increasing interest rates will send ripple effects throughout different markets from real estate to emerging markets. It can already be seen that in anticipation of the Fed raising interest rates, money invested in emerging markets have already be shifted from it. However, the ending results were shocking as the Fed decided that it is still not time yet to increase interest rates. So why didn't the Fed raise the interest rates? It is said that current economic outlook is still very weak and hence, this was not the right time to raise interest rates. There are many reasons by which why the Fed did not raise the interest rate and I will be summarising it for you.

1. A sluggish Inflation indicator. Despite the fact that unemployment has dropped to pre-crisis levels and that the Fed labor market index that tracks a range of data has recovered most of the reduction during the Great Recession, inflation is still at 0.2%. This can be seen as both a sign of weakness in the economy as well as an impediment to faster growth. The Fed has hence, released a statement that they will raise the rates should the economic outlook becomes more optimistic with labour market having further improvement as well as Inflation crawling to near 2%

2. Government Debt. If interest rates does increase, this mean that borrowing cost will also increase. Hence, this will greatly hurt the White House.

3.Mortgage rates are also very likely to rise. However, it is not the small increase in mortgage rates that the Fed and I presumed, is worried about. If the Fed did raise interest rates, this might cause a crash in the housing market of America. However, as I had mentioned, it is not the small increase in mortgage rate that might crash the housing market but on one other factor, Confidence.  If home buyers think rates are going to start marching up, confidence in the market may evaporate, leading to a crash in the housing market.


After discussing about the reasons why the Fed did not raise interest rates, let's look at the effects of this decision.

1.Currency Strength. I would like to draw you attention to this FOREX chart between EUR and USD. The following graph is charted in EUR/USD(1 HR)

This chart shows that the Euro dollar strengthen against the US dollar as the news was made. This resulted in a 148 pips movement in less than a day.
So, what does Interest Rates have to do with currency strength? Well, a higher interest rate offers users/lenders in an economy a higher return relative to other countries currency, hence attracting foreign capital and pushing the currency strength up.This is even better as since inflation in US is still low, the amount of return will be significantly higher. However, with the Fed stating that they will not increase the interest rates unless other factors such as improvement in the labour market are seen, this resulted in the weakening of the US Dollar and hence, causing a 148 pips movement in less than a day. However, I do feel that this strengthening is only temporary as investors will start to realise that the Fed will raise interest rates sooner or later.

2. Stock Market Movement. I would once again like to draw your attention to this particular graph of S&P 500. (Source: YahooFinance)

It can be seen that in anticipation of the Fed increasing interest rates, the stocks plummet to a cycle low of 1990.13. However, after the decision was made, this decision send stocks flying. But, it was short-lived. The gains were wiped off in mere-hours as investors start to realise that the Fed will increase the interest rates sooner or later. Hence, it decreased to a low of 1969.47. However, there are views that this might be the a bullish signal for the stock market and that it is beneficial to all investors. Truthfully, I don't not understand the concept behind it and hence, I will not attempt to explain the rationale behind it.



Lastly, I would like to express my final views. Do I think that the Fed decision in maintaining the Interest Rates a wise one? Yes I do. In my opinion, I think the Fed is making sure that the economy is stable enough before raising interest rates. At the same time, since inflation is still low, there is still uncertainty and hence, lack of a clear-cut indicator that the Fed should raise the interest rates. However, I believe all of us know that raising interest rates is imminent and that it is only a matter of time before the Fed does so. Hence, for me, I would personally be investing into USD once the next inflation report is being released and that it hits the appropriate range. I hope you guys had learnt something and please feel free to comment on my views and justification. As I am still a novice, I am prone to mistakes. Thank you for your time in reading my blog. Have a good day!