Morningstar's "Perspectives" series features investment insights from third-party contributors. Here, Mitchell Fraser-Jones of Woodford Funds discusses the global impact of the Fed raising rates.
The Federal Reserve has just announced the first increase in US interest rates in nearly ten years. Janet Yellen, Chair of the Fed, recently described the need for the rate hike as being “a testament… to how far our economy has come in recovering from the effects of the financial crisis and the Great Recession”.
![](/includes/images/QuotedTextTop.png)
When the cost of the dollar rises, it has an impact on individuals, companies and sovereigns
![](/includes/images/QuotedTextBottom.png)
We would agree with this assessment, to an extent, but the operative word in that statement is perhaps ‘our’. The US economy has, by some distance, been the best performing developed economy in the post-crisis world and, in some respects, does appear to have ‘normalised’. But that statement needs to be viewed in the context of just how low interest rates have been and for how long. This is an unprecedented period of economic history and nobody is really sure what normal should look like.
Furthermore, there may be far-reaching consequences of the Fed’s decision to raise US interest rates. The US dollar is still the world’s reserve currency, and when the cost of the dollar rises, it has an impact on individuals, companies and sovereigns that hold dollar-denominated assets and liabilities.
Already, we have seen emerging market economies struggling with the tighter liquidity conditions that have prevailed since the Fed ended its programme of quantitative easing last year. The currencies of many of these emerging economies have been under significant pressure in this period and that looks set to continue. Indeed, conditions may worsen, particularly if these economies feel that their only response to the growing pressures in their domestic economies is to intentionally depreciate their currencies even further.
Nowhere, is this more prominently the case than in China. Already, we have seen China loosening its grip on the renminbi in the face of an economic slowdown that looks like a hard-landing with almost every macroeconomic data-point. US interest rate increases are likely to put more pressure on the renminbi and are likely to increase the Chinese authorities desire to share their economic pain with the rest of the world through further currency depreciation.
Although an increase in US interest rates may be justified for the US economy, it is far from ideal for the rest of the world. The pace and extent of future rate increases is likely to be data-dependent, and it is plausible that the Fed will be cautious about hiking further in the next few months. But, in our view, tightening liquidity conditions already represent storm clouds for the global economic outlook.
So forget Star Wars – it’s the prospect of a new episode of Currency Wars that is occupying our thoughts. The dark forces of deflation and secular stagnation may be about to intensify.
With an investment strategy that has been formulated with a challenging economic environment in mind, we feel well-placed to cope with what lies ahead in 2016 and beyond. But we could be in for a bumpy ride next year and it will be as important as ever to be selective and to think long-term.
Disclaimer
The views contained herein are those of the author(s) and not necessarily those of Morningstar. If you are interested in Morningstar featuring your content on our website, please email submissions to UKEditorial@morningstar.com