Why US Interest Rates Matter To The Rest Of The World

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What's going on?

As we reported yesterday, the US Federal Reserve raised interest rates on Wednesday for the first time since 2006 and plans to raise rates even more next year – but what does that mean for the rest of the world?

What does this mean?

The effect for everyone else largely comes down to the impact that rising interest rates have on the value of the US dollar versus other currencies. When interest rates go up in a country, it attracts investment because investors can make more money via the higher interest rates. Since money, therefore, goes into the US economy, the value of the US dollar increases (because investors must buy dollars). That of course, pushes the relative value of all other currencies down, which has far reaching economic implications (see below).

Why should I care?

For markets: A strong US dollar has different effects on different economies. Emerging markets (EM) could struggle because they borrowed a lot of US dollars in the years after the 2008 financial crisis. This was partly because American investors were so keen to lend to them given the higher interest rates that EM countries/companies were prepared to pay. However, now that their currencies have sold off vs. the dollar, it has become much tougher for them to repay that US dollar debt. For developed markets like Europe and Japan, a strong dollar helps them sell their goods internationally - which provides a boost to their economies. The bigger picture: What matters is the future path of interest rates. While this interest rate rise was expected by markets, it’s currently unclear how interest rates will change next year. If they go up more than expected, the dollar will likely go up versus other currencies - and vice versa. What other central banks, like the European Central Bank and the Bank Of England, do with their interest rates will also have an impact on relative currency valuations.
Originally posted as part of the Finimize daily email.

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