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Expected Impact of US Rate Hike on Emerging Markets

As expected, Federal Reserve Open Markets Committee (FOMC) did not disappoint markets after their two day meeting. On Wednesday 14th December 2016, the committee unanimously decided to raise the bench mark interest rate by 25 basis points from 0.50% to 0.75%. Though market participants had already priced in an interest rate hike, US Dollar enjoyed a superb run against its major peers appreciating over 20% against Euro, Pound and Japanese yen.

Apart from raising interest rates, FOMC hinted on faster future interest rate hikes with markets expecting 3 interest rate hikes in the coming year 2017. The outlook is extremely optimistic considering the current rate hike comes after a one year dry spell.

The rate hike comes after US economy labor market continued to strengthen and economic activity expanded at a moderate pace. The Federal Reserve (FED) forecasted faster pace of GDP growth and slightly lower unemployment rate next year. Near term risks to the economy remains subdued while inflation has been increasing since early this year. The FED reiterated that the current monetary policy is accommodative in fostering maximum employment and price stability.

Also Read: Financial Risk Pricing Biggest Impediment To Growth of Kenya Financial Markets

Emerging markets may be exposed to capital outflows and weaker currencies after the US interest rate hike. US economy has been a major source of capital for emerging markets after they eased their monetary policies following the financial crisis of 2008. Their quantitative easing program which ended early this year and near zero interest rates fostered capital inflows into emerging markets.

The interest rate hike and signal of further interest rate hikes means that funds would be flowing back to the US economy hence exposing emerging markets to both capital outflow and weaker currencies. The funds repatriation would be in Dollars and investors would be selling emerging market currencies to buy Dollars which would cause the US Dollar to appreciate while emerging market currencies to depreciate.

The local economy may be affected further with the interest rate cap in effect. Kenya economy may have to raise interest rates to be competitive in the global markets and mute effect of the US interest rate hike. The local interest rate hike would also curtail capital outflows since the investor would have been given a higher return on investments. Higher prevailing interest rates in the global markets may mean that the Central Bank of Kenya may have to raise the Central Bank Rate (CBR) in their coming committee meeting.

The Kenyan Shilling may depreciate against US Dollar to around 105.00 levels in the next six months. Apart from capital outflow risks, general elections may dampen prospects of a robust local economy in the coming year.

Also Read: DIGITAL MONEY AGE: End of Central Banks’ control over money through Fractional Reserve Banking

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Posted by Timothy II Aperit

True believer in numbers. Statistics never lie. Bsc Financial Engineering MBA Finance ACCA