Overnight, the U.S. Federal Reserve (Fed) raised its official interest rate 0.25% to between 0.5% and 0.75%. No surprises there.
Of the 120 economists surveyed by Reuters, all of them expected the Fed to raise rates.
What do higher U.S. interest rates mean to me?
Since we are all consumers of goods, we are each affected by changes in the fortunes of the world’s largest economy. If you are an Australian investor, the implications are even more interesting.
Let’s start with the obvious. The Australian dollar ($A) falls. That means, travel becomes more expensive for those planning to tour America. Companies like Webjet Limited (ASX: WEB) or Flight Centre Travel Group Ltd (ASX: FLT) may have less people willing to travel to the Big Apple, Grand Canyon or Hollywood. However, some evidence suggests international travel is virtually unaffected by currency moves.
Consumer goods can also become more expensive. Technology, such as an iPhone or television, can become more expensive for local buyers if the dollar falls.
Perhaps counterintuitively, however, it can increase the competitiveness of local retailers like Harvey Norman Holdings Limited (ASX: HVN) or JB Hi-Fi Limited (ASX: JBH) because they can flex their purchasing power against low-cost competitors such as online shops.
Another big one is petrol. Most commodities, including iron ore and crude oil (a.k.a ‘petrol’ in consumer land) are traded in U.S. dollars. That means bigger profits for local commodities producers because they receive payment in U.S. dollars and have costs in Australian dollars. However, it means a heftier price tag when you fill up your car at the bowser. Yikes.
And here is the big one: debt gets expensive. For businesses that raise a lot of debt from overseas markets, such as Telstra Corporation Ltd (ASX: TLS) or CSL Limited (ASX: CSL), higher U.S. interest rates can spell trouble for obvious reasons. Most of them will ‘hedge’ their debt payments to lessen the effect. Nonetheless, it can hurt profits over time.
Banks are another example of high users of debt. If — I should actually say when — Australia’s banks look to fund mortgages, credit cards, car loans, etc., they will look to term deposits and U.S. debt markets. And because debt markets are more expensive, yep, you guessed it, it will make your loan more expensive over time. Double yikes.
Let’s not forget that over the past month we have witnessed the major banks raise interest rates.
From an investment point of view, I think Commonwealth Bank of Australia (ASX: CBA) is quite well placed for this trend given its high level of deposit funding.
What happens next?
Perhaps the most surprising development from the Fed’s rate rise was its expectations for higher interest rates going forward. Following its comments overnight, and the recent batch of political and economic data, U.S. interest rates could move rapidly higher in 2017 and 2018.
Think of those things that we just discussed in the paragraphs above from last night’s 0.25% increase. Now, think of them again — but imagine interest rates are more than three times higher than where they are today. That’s what some economists expect to see over the coming years, following the Fed’s remarks.
I don’t like to make forecasts, but higher interest rates could mean:
- More downwards pressure on the Australian dollar
- Higher prices of some consumer goods, and
- Rising costs of debt
Of course, it is not necessarily a bad thing that interest rates rise or the dollar falls. In fact, it could help our economy.
For example, it will likely ease some of the pressure in housing markets (both up and down, depending on the city), make Australian exports more competitive and increase tourism, potentially boosting the overall economy. If I were to guess, I’d say the Australian dollar won’t fall much further from here. But even small changes can be meaningful.
Taking a short-term macro view of investments is not a bona fide way to make money, in my opinion. But it can help you identify longer-term trends (three years plus) and opportunities that you may have otherwise missed.