The US Federal Reserve has raised the interest rate by 0.25% and expects that it will raise the rate another two times during 2018.
Jerome Powell, the Chairman of the Federal Reserve, said that the US economy is in great shape and “most people who want to find jobs are finding them.”
The Federal Reserve is projecting that unemployment could fall to 3.6% this year. Unemployment is close to the lowest in US history.
Ongoing job gains are boosting wages and confidence, which means that the Fed feels confident itself in raising the rates back to a neutral level, which is around 3% (or even higher).
The strength of the US economy has meant that the projection for three interest hikes for 2018 has turned into four. The Fed officials are predicting another three hikes in 2019 and one in 2020.
It appears that America is continuing to be great, first the recovery under Obama and now more growth under Trump.
Although the economy is going well, this is probably going to hurt share markets. Some investors may not have been expecting the rises to be as steep. Indeed, the S&P finished down 0.4% in the final hour of trade.
Interest rates act like gravity on asset valuations. Low interest rates have buoyed share prices of businesses, particularly ones like Transurban Group (ASX: TCL) and Sydney Airport Holdings Ltd (ASX: SYD). However, theoretically all share prices should somewhat drop.
This should also have more of an effect on defensive businesses like Ramsay Health Care Limited (ASX: RHC) and Cochlear Limited (ASX: COH) as well. It will also affect real estate investment trusts (REITs) as it will raise the interest cost and decrease the value of the buildings.
If people can choose to get a return great than 3% from US treasuries, then they could reduce their riskier share holdings.
The interest change could also mean our big banks like Commonwealth Bank of Australia (ASX: CBA) have to pass on an increase to loan holders because their funding has gone up in cost.
This rapidly rising interest could also have a big effect on emerging markets. A lot of governments and businesses have debt in US dollars. Therefore, the exchange rate could make that debt worse (compared to local currency) and then they have to pay more on that debt. Don’t be surprised if emerging markets have a blip (or more!) over the next year or two.
Don’t forget, the US economy is in a good position right now. It’s good the Fed is raising rates back to normal.
This could be what causes share prices to go back to more normal levels, which is better for everyone who is still buying shares. I’m going to keep my eye out for opportunities
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Motley Fool contributor Tristan Harrison owns shares of Ramsay Health Care Limited. The Motley Fool Australia owns shares of and has recommended Sydney Airport Holdings Limited and Transurban Group. The Motley Fool Australia has recommended Cochlear Ltd. and Ramsay Health Care Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.