5 ways the Fed rate hikes will hit global markets

It now looks almost certain that next week the Federal Reserve will raise interest rates for the third time, and that will be the first step on a clear path toward getting the price of money back to the 3% to 4% range.

That is a decision that will be taken for the United States. But American interest rates are also a key variable for the entire global economy.

First, it will mark the end of the era of super-cheap money. The Fed rate is still the most important in the world, the benchmark for the rate on every other financial asset. If that gets back to normal, then the price of everything will start to shift as well. True, the unique problems of Japan and the eurozone mean rates might stay low for longer in those two regions.

Secondly, prepare for inflation. It wasn’t what most people expected, but near-zero rates generated deflation. As the price of money goes up, inflation, which has been bottled up for years, will start to re-emerge. In the short term, that might actually be a good thing — but if it shows signs of getting out of control, there will be real problems ahead.

Three, expect savings rates to rise. At 0.25%, what was the point of putting any cash aside? Not much. You might as well just spend the stuff. With interest rates returning to normal, and with cash in the bank earning a reasonable real return, people will start to save again, especially in the developed world.

Four, expect huge budget pressures on governments. After the crisis, budget deficits ran out of control, and debt ratios soared. It didn’t matter much, however, because the cost of servicing all that debt was so low.

Finally, expect a trade war — between the U.S. and Europe. The dollar is inevitably going to rise sharply in value, especially against the euro. After all, why would anyone want to get zero or even negative rates on their money in Europe. A much weaker euro, probably below parity with the dollar, will blow the EU’s trade surplus sky high. By the end of 2018, that could be running out of control. Donald Trump will hate that, not least because it will be decimating the kind of high-end manufacturing jobs he has promised to protect. And he will find ways to hit back.

From next week, rates will start to normalize. It will be a long journey before they are back to the levels they have historically been at — two or three years at least. But when they get there, they global economy will look very different.

Source: MarketWatch

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