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What US interest rates hike means for global economy

FINANCIAL STANDARD
By Samuel Kiragu | December 20th 2016
Any monetary policy changes in the US cause knee-jerk reactions in global economies, with interest rates usually having great influence on global financial markets.PHOTO: COURTESY

Analysts and central bank bosses are still digesting the impact of the US Federal Reserve’s decision last week to raise interest rates. The Federal Open Market Committee (FOMC) raised the benchmark interest rate to 0.75 per cent.

Any monetary policy changes in the US cause knee-jerk reactions in global economies, with interest rates usually having great influence on global financial markets.

In the past, frontier and emerging market economies have appealed to the US government to delay interest rate increases due to the negative impact on their economies. The Fed has postponed a hike since June this year on concerns of a slowdown in the global economy, especially after the Brexit vote.

But with America having a robust economic outlook, the Fed believes an improvement in the labour market will put upward pressure on prices as money supply increases. An interest rate hike will, therefore, help control an expected inflation surge.

The US is a major source of capital for frontier and emerging markets like Kenya, which makes Fed interest rate movements important. The immediate impact will be a foreign capital pull-back from these markets. The flow of this money back to the US will hurt financial markets. With significant foreign investors in our financial markets, equity markets may witness some sell offs.

The Fed rate increase means US bonds will pay higher interest rates, so we may witness stock market volatility as American investors liquidate their interests in Nairobi Securities Exchange-listed companies to seek returns from domestic assets.

Currency turmoil

A stronger dollar resulting from the Fed rate may lead to currency turmoil in frontier markets, Kenya included. The greenback has been on upward trajectory, pushing the shilling to levels above Sh100. This boost in the dollar will impact commodity prices. But while exporters will earn more shillings from their products, there may be net harm done to the Kenyan economy as we are net importers, which means products procured from abroad will become more expensive.

An accumulation of dollar loans during a period of interest rate surges is not good for the Treasury or businesses, as it leads to higher debt servicing costs. Domestic borrowing would shield the Treasury from interest and foreign exchange risks.

Further, any new foreign currency-denominated debt issued by the Government must offer attractive yields to attract foreign investors since they have the option of investing in more secure home-based securities.

The writer is a financial services professional based in Canada. [email protected]

 

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