26 October 2016
The Fed rarely makes big changes to interest rates prior to a US presidential election. Photo: Bloomberg
The Fed rarely makes big changes to interest rates prior to a US presidential election. Photo: Bloomberg

US has limited room for interest rate hike

It’s widely expected that the US Federal Reserve will hike interest rates next month. 

The Fed funds rate shows that the chance of a rate hike before year-end soared to nearly 70 percent recently from less than 30 percent in mid-October.

However, I believe there is very limited room for a Fed liftoff.

The biggest threat to global financial markets, in particular emerging markets, is not the Fed liftoff, but the strength of the US dollar.

A rate hike might trigger a surge in the US dollar.

The exchange rate is closely linked with the size and pace of the monetary easing measures of major central banks.

Simply speaking, more money printing or large-scale quantitative easing would exert more pressure on the currency.

The US dollar has moved in tandem with the launch and withdrawal of QE since the 2009 financial crisis.

If the Fed has decided to go against the crowd, while the central banks in the eurozone and Japan still intend to expand their QE programs, the US dollar might post another run-up.

That would lead to a series of crises, as we’ve seen in the market turmoil in the emerging markets in the third quarter.

That has indirectly restricted the room for a US rate hike.

Also, credit expansion could lead to problems in the United States.

The US has started to ramp up its leverage again as a result of the massive monetary easing.

The debt of households, companies, businesses and consumers has expanded 25 percent since 2009 to US$52.4 trillion.

A steep rate rise might trigger a deleveraging and stifle the country’s economic recovery or damage the economy even more.

Also, the US Treasury has a record outstanding debt of US$18.6 trillion.

It paid more than US$430 billion in interest last year alone.

Meanwhile, the US is unlikely to decouple from struggling economies in other parts of the world.

The strong greenback has already weighed on the earnings of US firms.

The net profit margin of firms in the S&P 500 Index fell to 8.4 percent from a peak of 9.65 percent in the fourth quarter of last year.

Plunging commodity prices may suppress inflation and indirectly restrict the room for hiking the interest rate.

The US consumer price index was flat, and core personal consumption expenditure increased by 1.3 percent, which reflects looming deflationary pressure.

In addition, the US will hold a presidential election next year.

For political reasons, the Fed might not impose a dramatic rate hike.

Its monetary policy has been very modest before presidential elections, rate changes averaging 0.07 percentage points, data since 1972 shows.

This article appeared in the Hong Kong Economic Journal on Nov. 12.

Translation by Julie Zhu

[Chinese version中文版]

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Hong Kong Economic Journal chief economist and strategist

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