Federal rate hike, and the effect on Australia and Asia.

The global effects of the historical Fed rate hike rise and what it means to the rest of the world.


The interest rate hike came as no surprise, with both markets and economists expecting the move, though most were taken by surprise that the central bank plans to raise the cost of borrowing three more times in 2017, rather than just two.


And while it's happening on the other side of the world, there are some implications for Australians and our economy:


The Australian Dollar


Many traders see the Fed's increase in interest rates as a signal the US economy is in better shape, which has prompted more people to want to own US dollars. As such, the Aussie dollar has fallen as traders buy the greenback.


Just prior to the announcement, at 6am on Thursday, the Aussie dollar had hit its highest since November 8 at US75.25c.


This shows that many traders expected the US Fed to be more cautious – or dovish – than they were. Following the news of the three planned rate hikes for 2017, the US dollar shot up and the Aussie fell; about 0.6 per cent to US74.52c and is continuing to drift lower.


"This shows the air above 75c for the Aussie continues to look very thin," says Ray Attrill, co-head of FX strategy at National Australia Bank. "And we expect the Aussie dollar to come lower in the next year as the US dollar continues to strengthen."


However, many argue the Australian dollar is still relatively strong, thanks to a resurgence in commodity prices, which might complicate things for the Reserve Bank of Australia.


"If the Aussie stays too high, then we could certainly see the RBA come back into play," says Mr Attrill.


Australia's central bank wants to make sure the local currency doesn't become too strong so that the goods of our exporters aren't too expensive for foreign buyers.


The RBA is monitoring the transition of the Australian economy away from such a heavy reliance on the mining industry, and a high exchange rate reduces GDP growth in the medium term.


What happens next to the Reserve Bank of Australia?


Central banks around the world had lowered their interest rates alongside the Fed in the wake of the GFC to encourage spending and growth in their economies, and the RBA was no different.


The RBA's cash rate is at a record low 1.5 per cent. Economists are divided over whether policy makers might cut it further, though a lower local dollar and a positive outlook for the US have eased those fears somewhat.


"This move by the US Fed is broadly quite good for the Australian economy," says Jo Masters, senior economist at ANZ.


"It's a sign that the recovery in the US economy is sustainable and is recovering as planned. A strong US economy is good for global growth, and given we're a small open economy, we tend to do well when global growth is looking better."


Home Loans


More expensive debt in the United States is unlikely to have a material effect on the repayments of mortgages in Australia, however there is a correlation between bond yields and home loans.


Long-term fixed mortgage rates, both in Australia and in the US, are pegged to bond yields. Recently, bond yields – the return on government debt across the globe have been rising as the outlook for global growth picks up.


Indeed, just after the interest rate announcement yields on shorter-dated US Treasuries hit their highest in five years.


Given this recent recovery in bond yields, some Australian banks have moved to increase their fixed-term loans. This impacts customers taking out new loans, rather than those with existing fixed rate loans.


Commonwealth Bank of Australia, National Australia Bank and Westpac have increased their fixed rate interest loans in the last month, blaming the cost of wholesale funding.


US mortgage rates have risen by more than 50 basis points since the November election.


Stock Markets


Following the announcement that debt will be slightly more expensive, US shares fell and finished the session down.


But markets were largely expecting the US Fed's decision and traders were mostly repositioning on the news there are three planned hikes next year, rather than just two.


ASX listed companies who do business in US dollars are likely to experience a lift, given the greenback has strengthened so considerably which will mean their profits generated in US dollars will be higher when translated back into Aussie dollars.



However those who import from the US are in for a rough time as imported goods become less affordable for them with a weaker Aussie dollar.


Stock markets more broadly have rallied in recent times and this is likely to continue for the time being. US equities repeatedly hit record highs following the election of Donald Trump to the White House with his promise to increase fiscal spending.


While there is no concrete plans for just how much spending is planned or on what kinds of projects, investors have flooded into the stock markets optimism sweeps the globe, just like it did at the beginning of Ronald Reagan’s term of office.
Deregulating the markets always does well in the short term.


Australian shares have recently pushed higher too, with resources and banking stocks running hard in the wake of the US election and surging commodity prices.


However following the US Fed's announcement this morning, Australian shares fell at the open, taking their lead from Wall Street. An increase in interest rates generally bodes well for banks, who receive revenue in the form of interest repayments, however traders expect financial stocks to open flat this morning.


Summary of what Yellen said.


Federal Reserve chair Janet Yellen spoke at a press conference after the two-day meeting and gave some insight into the central bank's thinking.


The Fed has raised its GDP growth forecast from 2.0 per cent to 2.1 per cent, which isn't very material at all. And the unemployment rate forecast was cut marginally to 4.5 per cent from 4.6 per cent.


Commenting on the Trump share market rally, Dr Yellen warned that there was "considerable uncertainty about how economic policies may change, and what effect they may have on the economy."


She also stressed the independence of the central bank in face of the President-elect'srepeated attacks during the election campaign.




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Dec 14, 2016