Fed Holds Rates at 22-Year High, But Leaves Hikes on the Table

The Federal Reserve (Fed) announced on Wednesday, November 1, 2023, that it would keep its benchmark interest rate unchanged at a range of 5.25%-5.50%, the highest level since 2001. The Fed cited strong economic growth and rising inflation as the main reasons for its decision, but also left the door open for further rate hikes in the future.

The Fed’s interest rate affects the cost of borrowing and lending money in the U.S. and around the world. A higher interest rate makes it more expensive for consumers and businesses to take out loans, mortgages, credit cards, and other forms of debt. This can reduce spending and investment, which are key drivers of economic activity.

However, a higher interest rate can also help control inflation, which is the increase in the prices of goods and services over time. Inflation erodes the purchasing power of money and can hurt the economy if it becomes too high. The Fed’s main goal is to keep inflation around 2% per year, which it considers a healthy level for economic stability and growth.

According to the latest data, the U.S. economy grew by a robust 4.9% in the third quarter of 2023, fueled by strong consumer spending and business investment. However, inflation also surged to 4.2% in September, well above the Fed’s target. The Fed attributed the rise in inflation to temporary factors, such as supply chain disruptions, labor shortages, and higher energy prices, but also acknowledged that inflation could remain elevated for longer than expected.

The Fed said that it would continue to monitor the economic situation and adjust its monetary policy accordingly. The Fed also reiterated that it would gradually reduce its bond-buying program, which it started in response to the COVID-19 pandemic to inject liquidity into the financial system and support the economic recovery. The Fed plans to end its bond purchases by mid-2024.

The Fed’s decision to hold rates steady was widely expected by analysts and investors, who had already priced in the possibility of further rate hikes in 2024. The Fed’s projections show that most of its policymakers expect at least two more rate increases next year, bringing the interest rate to a range of 6%-6.25% by the end of 2024.

The impact of the Fed’s interest rate policy on the U.S. economy and the global markets depends on various factors, such as the strength of the economic recovery, the evolution of inflation, and the reactions of consumers, businesses, and investors.

Some of the possible effects are:

A stronger U.S. dollar: A higher interest rate makes the U.S. dollar more attractive to foreign investors, who can earn higher returns by holding dollar-denominated assets. This can boost the demand for and value of the dollar relative to other currencies. A stronger dollar can have both positive and negative effects on the U.S. economy. On one hand, it can make U.S. exports more expensive and less competitive in foreign markets, which can hurt U.S. manufacturers and exporters. On the other hand, it can make imports cheaper and more affordable for U.S. consumers, which can lower inflation and increase purchasing power.

Higher borrowing costs: A higher interest rate increases the cost of borrowing for consumers and businesses in the U.S. This can affect various sectors of the economy, such as housing, auto, retail, and manufacturing. For example, higher mortgage rates can discourage home buyers and sellers, leading to lower demand and supply in the housing market. Higher auto loan rates can reduce car sales and production. Higher credit card rates can reduce consumer spending and confidence.

Lower stock prices: A higher interest rate can also affect the stock market, as it reduces the present value of future earnings and dividends for companies. This can lower their stock prices and valuations, especially for those that rely heavily on debt financing or have high growth expectations. Higher interest rates can also increase uncertainty and volatility in the market, as investors adjust their portfolios and expectations accordingly.

Mixed effects on emerging markets: A higher interest rate in the U.S. can have mixed effects on emerging markets, which are developing countries that have high growth potential but also face various economic challenges and risks. On one hand, a higher interest rate in the U.S. can attract capital away from emerging markets, as investors seek higher returns in safer assets. This can reduce foreign investment and financing for emerging markets, which can hurt their economic growth and stability.

It's Impact on major trading partners of US:

The impact of the US interest rate policy on the economies of its major trading partner countries depends on various factors, such as their trade balance, exchange rate, inflation, and growth prospects. Here are some possible scenarios for some of the US’s major trading partners:

China: China is the largest trading partner of the US, with a trade volume of over $600 billion in 2022. China runs a large trade surplus with the US, meaning that it exports more than it imports from the US. A higher interest rate in the US could strengthen the US dollar against the Chinese yuan, making Chinese exports cheaper and more competitive in the US market. This could boost China’s trade surplus and economic growth. However, a stronger dollar could also increase the cost of servicing China’s dollar-denominated debt, which was estimated at $2.5 trillion in 20212. Moreover, a higher interest rate in the US could reduce the demand for Chinese goods in other markets, as global investors shift their funds to the US. This could hurt China’s export-oriented economy and slow down its growth.

Canada: Canada is the second-largest trading partner of the US, with a trade volume of over $500 billion in 2022. Canada runs a small trade deficit with the US, meaning that it imports more than it exports from the US. A higher interest rate in the US could weaken the Canadian dollar against the US dollar, making Canadian imports more expensive and Canadian exports more affordable in the US market. This could reduce Canada’s trade deficit and stimulate its economy. However, a weaker Canadian dollar could also increase inflation in Canada, as imported goods become more costly. Moreover, a higher interest rate in the US could affect Canada’s financial sector, as Canadian banks and borrowers face higher interest rates and tighter credit conditions.

Mexico: Mexico is the third-largest trading partner of the US, with a trade volume of over $400 billion in 2022. Mexico runs a small trade surplus with the US, meaning that it exports more than it imports from the US. A higher interest rate in the US could appreciate the Mexican peso against the US dollar, making Mexican exports more expensive and less competitive in the US market. This could reduce Mexico’s trade surplus and economic growth. However, a stronger peso could also lower inflation in Mexico, as imported goods become cheaper. Moreover, a higher interest rate in the US could attract foreign investment to Mexico, as Mexico offers higher returns than other emerging markets.

Japan: Japan is the fourth-largest trading partner of the US, with a trade volume of over $200 billion in 2022. Japan runs a large trade surplus with the US, meaning that it exports more than it imports from the US. A higher interest rate in the US could appreciate the Japanese yen against the US dollar, making Japanese exports more expensive and less competitive in the US market. This could reduce Japan’s trade surplus and economic growth. However, a stronger yen could also lower inflation in Japan, which has been struggling with deflation for decades. Moreover, a higher interest rate in the US could increase the demand for Japanese government bonds, which offer negative yields, as a safe haven asset.

Germany: Germany is the sixth-largest trading partner of the US, with a trade volume of over $200 billion in 2022. Germany runs a large trade surplus with the US, meaning that it exports more than it imports from the US. A higher interest rate in the US could depreciate the euro against the US dollar, making German exports cheaper and more competitive in the US market. This could boost Germany’s trade surplus and economic growth. However, a weaker euro could also increase inflation in Germany, which is already above the European Central Bank’s target. Moreover, a higher interest rate in the US could affect Germany’s financial sector, as German banks and borrowers face higher interest rates and tighter credit conditions.

United Kingdom: The UK is the fifth-largest trading partner of the US, with a trade volume of over $200 billion in 2022. The UK runs a small trade deficit with the US, meaning that it imports more than it exports from the US. A higher interest rate in the US could weaken the British pound against the US dollar, making UK imports more expensive and UK exports more affordable in the US market. This could reduce UK’s trade deficit and stimulate its economy. However, a weaker pound could also increase inflation in the UK, which is already above the Bank of England’s target. Moreover, a higher interest rate in the US could affect UK’s financial sector, as UK banks and borrowers face higher interest rates and tighter credit conditions.

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