The US dollar has fallen by more than 4% since the beginning of the third quarter, wiping out most of its gains made in 2024. This comes amid growing expectations that the Federal Reserve will soon begin to ease its monetary policy by cutting interest rates.
According to Deutsche Bank Research, the market is now pricing in a relatively large cycle of easing by the Federal Reserve, and as a result, the US dollar is likely to lose its place among the top three high-yielding currencies by next year.
Investors expect the Federal Reserve to begin cutting interest rates at its September 18-19 meeting, which will be reflected in the dollar's price in the currency trading market . Expectations in the federal funds futures market suggest a 57% chance that the Federal Reserve will cut its benchmark interest rate (which it currently holds at a target range of 5.25% to 5.50%) by a quarter of a percentage point, according to the CME FedWatch Tool. There is a smaller, 43% chance of a half-point rate cut in September.
What's next for US interest rates?
The Federal Reserve left interest rates unchanged at its latest meeting in July for the eighth consecutive time, keeping the benchmark interest rate at a range of 5.25% to 5.50%, its highest level in 23 years.
While the Fed didn't take any steps to ease its monetary policy at its July meeting, it did say that further progress has been made in lowering inflation to its 2% target, a sign that the central bank is getting closer to cutting its key interest rate for the first time in four years.
Recently, Fed officials have hinted that the recent progress in lowering inflation may allow them to cut interest rates soon. At the Jackson Hole conference, Federal Reserve Chairman Jerome Powell suggested that a rate cut could come as early as September, and that further rate cuts would depend largely on data.
Although inflation is still slightly above the Fed's 2% target, it continues to move in the right direction towards the bank's goal, paving the way for the Fed to lower borrowing costs in the near future. Additionally, the bank is also concerned that waiting too long to cut rates could unnecessarily weaken the labor market, which could impact economic growth. However, the bank has kept rates high for an extended period to gain more confidence that inflation is moving sustainably towards 2%.
How do interest rates affect the US economy?
Experts say that the Federal Reserve uses interest rates "like a gas pedal and a brake pedal," with lowering rates stimulating the economy and raising rates slowing it down. It also typically takes "at least 12 months" for changes in rates to have a broad economic impact, while the stock market reacts immediately.
For example, when Federal Reserve Chairman Jerome Powell hinted at the possibility of raising interest rates again last year, the market went into a tailspin and major indices fell by more than 1%, while Treasury yields rose and the US dollar extended its gains.
How do US interest rates affect the global economy?
Since the United States has the world's largest economy, every economic move it makes has an immediate impact on global markets. High interest rates are creating growing concerns about their global impact, especially on emerging economies, due to the rising value of the US dollar, which coincides with the rising interest rate. The US dollar is used as a benchmark for current and future economic growth in many countries around the world.
Higher US interest rates affect foreign economies in the same way they affect the domestic economy, reducing GDP in foreign economies. Estimates suggest that a rise in US interest rates reduces the GDP of advanced economies by 0.5% and emerging economies by 0.8% after three years. This increase in rates affects countries that peg their currencies to the US dollar or that have large trade volumes with the United States.
1- Rising Dollar
Following the global financial crisis in 2008, the Federal Reserve implemented years of quantitative easing to stimulate economic recovery, lowering interest rates to near zero, where they remained for the next six years. The rationale was to boost investment and consumer spending and pull the US economy out of recession. In the years that followed, the economy entered a recovery phase.
In the wake of the COVID-19 pandemic and the significant rise in inflation levels, the Federal Reserve began raising interest rates, a process that continued until 2023.
Historically, higher interest rates have gone hand-in-hand with an increase in the value of the US dollar, which has affected economic aspects both domestically and globally, particularly in credit markets, equities, commodities, and investment opportunities.
A strong dollar, often accompanying rising rates, tends to boost US demand for products around the world.
2- Treasury Bonds
US bonds are directly linked to changes in US interest rates. In the United States, the Treasury yield curve indicates changes in domestic interest rates. As the yield curve moves up or down, global prices are adjusted accordingly.
Since US Treasury bonds are considered risk-free assets, with the expectation of rising interest rates, global investors rush to deposit their money in the United States. This puts immense pressure on emerging markets to remain attractive. Ultimately, this could hinder employment rates in developing countries, along with exchange rates and exports.
3- Dollar-Denominated Debt
Emerging markets are typically affected by rising interest rates in the United States and the strength of the US dollar. Countries like Brazil, Turkey, and South Africa, which suffer from persistent trade deficits, finance their account deficits by accumulating dollar-denominated debt.
Emerging markets are typically affected by rising interest rates in the United States and the strength of the US dollar. Countries like Brazil, Turkey, and South Africa, which suffer from persistent trade deficits, finance their account deficits by accumulating dollar-denominated debt.
4- The Credit Market
Concerns about rising interest rates can be seen in their contractionary effect on credit and money supply. Basic economic theory suggests that higher interest rates lead to a decline in money supply and an increase in the value of the dollar. At the same time, the lending and credit market shrinks.
The credit market follows movements in Treasury bonds. As interest rates rise, the cost of credit increases, and borrowing becomes more expensive, from bank loans to mortgages. Consequently, the higher cost of capital can hinder manufacturing, consumption, and production.
The deeper consequences of rising interest rates in the United States are expected to come at the expense of Asian economies. This leads to an acceleration of financial flows from Asian countries, led by China, creating further instability.
Historically, China has borrowed from foreign banks to boost economic growth. This borrowing was driven by lower interest rates, but as credit conditions tighten, foreign lending to debt-laden countries has declined.
5- The Commodity Market
Gold, oil, gas, and other global commodities are priced in US dollars. With a strong US dollar following rising interest rates, commodity prices rise for holders of non-dollar currencies.
Economies that rely primarily on the production of commodities will be worse off, as slowing economic growth will lead to a decline in demand for commodities.
6- Foreign Trade
Despite the negative impact of US interest rates on the global economy, rising interest rates are beneficial for foreign trade. A stronger dollar accompanying rising rates can boost demand for products in all countries around the world, increasing profits for both domestic and foreign companies.
And since fluctuations in the stock markets reflect beliefs about whether industries will grow or shrink, the resulting increase in profits will lead to a rise in the stock market.
How US Interest Rates Affect China
When interest rates rise, the cost of borrowing money becomes more expensive. When goods and services become more expensive, people stop spending, and this begins to slow down the economy. Businesses react by slowing down production, which leads to further slowdowns and increased unemployment. Increased unemployment means people continue spending less because they don't have jobs, which continues the cycle of contraction.
An increase in US interest rates would strengthen the dollar, making Chinese exports more expensive. This would make Chinese exports less competitive and hurt the Chinese economy. Conversely, a decrease in US interest rates would have the opposite effect.
What Price Increases Mean for Your Portfolio
As experts say, "rising interest rates are a mixed bag for consumers." When the Federal Reserve raises interest rates, consumers will pay higher interest rates on debts such as credit cards. However, on the other hand, savings rates also tend to rise. In the face of rising interest rates, experts offer the following advice:
1. Pay off any debt: You should pay off your debt before interest rates rise. While the impact may seem gradual at first, continuous increases can eventually make it more difficult to repay debt.
2. Fix the prices if you can: For those with a home equity line of credit, consider fixing a lower interest rate on part or all of your balance.
In Conclusion
Interest rates are key indicators of economic growth. In the United States, the Federal Reserve's move to cut interest rates is expected to spur growth and delight investors, while calming the economy itself.
- US Dollar largely erases 2024 gains amid expectation of federal rate cuts. - 17 September, 2024
- Rare currency pairs in the Forex market - May 26, 2023
- Key tips for traders in Forex Market - April 20, 2023
