Why is the Fed so tough?
US central banks are concerned about rising inflation. Inflation in the US rose to 7 percent in December, partly due to much higher energy costs. That is the highest level in more than 40 years. Core inflation – adjusted for energy and food – is now also 5 percent. The Fed is also keeping a close eye on the tight labor market. This can lead to higher wages, which in turn can lead to higher prices.
An increase in interest rates means that companies are less likely to borrow money for new activities. This leads to a decrease in economic activity and therefore inflation. Higher interest rates can be easily absorbed by the economy, Powell said, because the labor market is tight. Unemployment has fallen below 4 percent. The Fed probably won’t stick with a one-off hike. It is possible that 0.25 percent will be added at every meeting (once every six weeks) after March.
Will this not have unpleasant consequences for the euro and other currencies?
If interest rates in the US rise and those in the eurozone remain at 0, this will lead to a more expensive dollar. There will then be more demand for the dollar, because higher interest rates make it more lucrative to put money away in dollar bonds. That can lead to tensions. The US has very large trade deficits, while the eurozone has a trade surplus. The US is now becoming less competitive and the Eurozone more competitive. This also applies to Japan, which also has a large trade surplus with the US.
Will the Dutch consumer also notice something of a more expensive dollar?
Dutch consumers and companies may be faced with higher costs. Many commodities, such as oil, are settled in dollars. A more expensive dollar means that inflation in the Netherlands will rise further. There is no direct influence on the mortgage interest rate.
Could the eurozone be left behind?
The European Central Bank is faced with a dilemma. Here too, inflation is rising. In the Netherlands, this has increased on an annual basis to 6.4 percent (Eurostat) or 5.7 percent (CBS). In the entire eurozone, it is now at 5 percent. In many countries outside the eurozone (Poland, Norway, UK, Czech Republic) interest rates have already been raised due to rising inflation.
Still, ECB President Christine Lagarde said in December that interest rates will not be raised in 2022. That will happen next year at the earliest. One of the reasons for the ECB’s reluctance is that many southern member states of the eurozone could find themselves in difficulties in financing the enormous government debt due to an interest rate hike. However, the ECB does intend to end the additional bond-buying program that had been set up because of the pandemic in March. But the normal buying program remains intact.
Why were stock investors shocked by Powell’s announcement?
Higher interest rates make bonds and savings accounts more attractive as an investment. This means that investors will start selling shares and other financial assets (gold, cryptocurrencies). Share prices have fallen sharply since November in anticipation of the Fed’s decision. The value of cryptocurrencies when Bitcoin is halved. Many investors had bought crypto coins because the returns on savings accounts had turned negative. Now they want to get rid of it.
Why do even the emerging economies in Asia and Latin America suffer from this?
Higher interest rates on the dollar stimulate capital flight to the US currency, putting pressure on domestic currencies such as the Turkish lira, Argentine peso, Indian rupee and Indonesian rupiah. In addition, in these countries a lot was borrowed in dollars because the interest on dollar loans was much lower than on their own currency. But if the dollar rate rises, those loans also have to be repaid in much more expensive dollars.
In 2014, many companies in those countries got into serious trouble and even went bankrupt when the Fed decided to raise interest rates again for the first time since the credit crisis. Their own currencies fell, making imports significantly more expensive as well. The Fed only focuses on its own national interests, but the dollar is the world’s reserve currency. 80 percent of all trade transactions are made in dollars. In addition, the US dollar is also the currency of countries that no longer have their own currency, such as Ecuador, El Salvador and Zimbabwe.