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Fed Interest Rate Increase

Source: Taiwantrade | Updated: 18 December 2015


On December 16, 2015, the U.S. Federal Reserve’s (Fed) policy-making committee decided to raise its benchmark interest rate by 0.25 percent. The move marks the first time since the financial crisis in 2006 and signals the commencement of the end for the Fed’s stimulus program—zero interest-rate policy. The key factors that lead to the hike in interest rates include the outstanding performance of U.S. economy and continuing downward trend in its unemployment rate. The Fed considers that inflation might take place if the job market is almost fully-employed, and economy keeps expanding. Rate increase therefore has become the Fed’s follow-up resolution to curb inflation.
 

What influence and impact will the Fed’s hike in interest rates exert on the global economy? First of all, an outflow of capital from emerging markets to the U.S. makes the dollar appreciate. Second, currency depreciation is expected to happen in emerging markets such as Mexico, Brazil, Russia, Indonesia, Turkey and South Africa. Third, spillovers of stronger greenbacks render heavier the corporate debts in dollars from different countries and further contribute to the likelihood of default crisis. Worst, commodity exporting countries will see their revenues decrease subsequently after a drop in commodity prices.
 

There has been little chance that China could refrain from the impact of U.S. rate increase, including capital outflows and debt default. Nevertheless, such impact could be minimized to the lowest degree because China, the second largest economy in the world, is the driving force behind global economic growth; furthermore, the inclusion of China’s currency Renminbi in the IMF’s Special Drawing Rights (SDR) basket has cushioned the decline of its value against the U.S. dollar.
 

Different from the U.S.’s tight monetary policy, Japan and the Eurozone implement the expansionary one in that their respective economy is still stagnant. The Fed’s interest rate increase will induce the U.S. dollar’s appreciation and Japanese yen’s depreciation. The weak Japanese yen, however, will spur the Japanese stocks to soar, increase the exports of Japanese goods and benefit the businesses in terms of their profits. Analogically, the Eurozone adopts the relaxed monetary policy to drag itself out of the sluggish economy. The market will refocus on the euro parity with the U.S. dollar given that the rate increase gives rise to the depreciation of the former and appreciation of the latter. Taiwan is also susceptible to capital outflows in the wake of the U.S. rate rise. Nonetheless, neither is Taiwan a commodity exporter, nor does it have heavy external debt. Taiwan’s stocks may retreat as investors pull back their capital. In addition, Taiwan dollar’s fall against the U.S. dollar gives advantage to the country’s exports.

 


Ya-Chin Chen(yachin@taitra.org.tw)

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