What To Do When US Interest Rates Rise

When America embarked on its audacious experiment of flooding the US economy with cheap money, many economists were sceptical. They could not believe that Quantitative Easing would achieve anything other than chaos.

When America cut interest rates to almost zero, many economists were sceptical. They could not envision how or, indeed, whether a Zero Interest Rate Policy would work.

But the two monetary policies in tandem have worked a treat. America’s economy is back on an even keel. Unemployment in the US has fallen to 5% and the average hourly wage paid to American workers posted its strongest 12-month gain since 2009.

Additionally, 271,000 jobs were created in October, which were almost 100,000 more jobs than economists were expecting.

Time for a change

With the US economy showing early signs of recovery, the US Federal Reserve has now indicated that it is ready to slowly reverse out of its Zero Interest Rate Policy. It has already stopped printing money.

There have been strong signs, recently, from the US Federal Reserve that American interest rates could start to rise as early as next month.

As expected, economists are, once again, sceptical. They are again forecasting chaos. Whether these are the same economists that were sceptical eight years ago when interest rates were cut is unclear. But economists are more than capable of changing their tune. It is their job to be sceptical.

First time in a decade

A rise in interest rates next month would be the first time in almost a decade that the cost of borrowing has gone up in the US. It will be a new experience for many to learn, for the first time, that the direction of interest rates is not a one-way bet – they can rise as well as fall.

That said, a rise in US interest rates could be quite far-reaching, even for us in faraway Singapore, where interest rates could also be affected.

Perhaps the biggest impact of a US rate rise could be a gradual appreciation of the US dollar against many currencies around the world, including the Singapore dollar. It is already happening.

Only a year ago, one US dollar would have bought S$1.32. Today, the same dollar could buy S$1.42 – a rise of almost 8%. Some might point to the rising dollar or the falling Singapore dollar as a reason to be worried.

But let us not forget that it was only nine years’ ago when the US dollar almost breached S$1.70 against our local currency.

Yet over the last eight years, companies such as Jardine Matheson (SGX: J36), ComfortDelGro (SGX: C52) have still delivered total annual returns of 16% and 12%, respectively.

And there’s more…

Another significant impact of rising US interest rates, which could lead to a higher US dollar, could be lower commodity prices. There are many reasons as to why commodity prices could fall when the dollar rises.

The main one is because many commodities such as oil and gas are priced in dollars. So when the value of the dollar rises, it will require fewer dollars to buy those same commodities. Consequently, many commodity prices could fall. The upshot is that businesses that are inextricable linked to commodities such as miners, oil and gas explorers and farmers could be hurt.

We have already seen some evidence of that. But despite a rising dollar and a fall in commodity prices, companies such as Keppel Corporation (SGX: BN4) and Wilmar International (SGX: F34) have been able to continue paying dividends, if not increase them over the last decade.

An imminent rise in US interest rates has been the focus of concern in financial markets ever since the former head of the Federal Reserve, Ben Bernanke, hinted that monetary easing could end. Some companies, perhaps, have good reason to be concerned. But it would be wrong to infer that all companies could suffer.

Winners and losers

It is just not true that there is an inverse relationship between rising interest rates, a strong dollar and share prices. But even if it was true for the overall market, certain industries or segments of the economy could benefit.

They may even have earnings and dividends that react positively to interest changes. In those situations, their share prices might even be positively correlated to changes in interest rates.

But let us not lose sight of why interest rates are about to go up in the US.

It could be a sign that the world’s largest economy, America, is improving. That could benefit many businesses that export to America, make their revenues in America and have assets in America.

A healthier America should be a time for stock market investors to celebrate – it is certainly not a time to hold a wake.

A version of this article first appeared in the Independent on Sunday.

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