Podcast 11th December 2015
The worry for emerging markets such as India when the US Federal Reserve (Fed) starts to hike interest rates is capital outflows. Capital outflows caused by foreign investors taking money out of emerging markets and reinvesting in the US can drive down value of currency, bonds and equities in emerging markets.
The Fed is expected to hike interest rates for the first time in over eight years in its policy meet on the 15th and 16th of December 2015. Fed policy rates are at close to zero percent levels, levels held since December of 2008. The reason Fed is staring to hike rates from close to zero percent is that the it sees the US economy mending and coming out of the deep slump caused by the global financial crisis in 2008. Unemployment rate that rose from 5% levels to 10.5% levels has come off to 5% levels over the 2007 to 2015 period. Inflation that has been trending below 2% is on track to go up to Fed target levels of 2% over the next couple of years.
The common question asked in the face of Fed rate hikes is “How will it affect my investments?” the answer being capital outflows lowering the value of currency, bonds and equities. However, in the current context, a Fed rate hike is more positive than negative for markets and the question should be rephrased as “How will a Fed rate hike help my investments?”
The Fed normalizing policy rates by raising rates from close to zero percent levels will take out the complacency in markets that have got used to borrowing at almost no cost. Such zero cost borrowing fuels speculation driving up asset prices to bubble like levels and that in fact is the worst scenario for your investments. Markets and asset prices will start to behave rationally and that in turn will help you construct a portfolio of securities that are reasonable valued.
The Fed is starting to normalize policy due to the strength shown by the US economy. A strong US economy is positive for global economies as it has a spill over effect on other economies either through trade or through remittances. This drives both investment and consumption in emerging economies leading to higher economic growth, which in turn will benefit your investments.
Given that interest rates in the US are close to zero percent, rates will not push up borrowing costs dramatically in the US unless hikes are sharp and fast. The Fed has guided for a gradual pace of rate hikes. Interest rates are closer to 7% in India and much higher than zero percent in many other emerging markets. Taking money out of high yielding assets to invest in low yielding assets will not be an optimum investment strategy.
Hold on your investments, if you have invested smart and do not let Fed rate hikes make you take sub optimal investment decisions.
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