June 14, 2021 | AtoZ Markets– On Wednesday, all investors will have their ears to the ground as to whether or not the U.S. Federal Reserve will make changes to its current monetary policy.
Some analysts speculate that the U.S. central bank could raise interest rates earlier than expected due to the high levels of inflation that the world’s leading economy is going through, however, this does not seem to be a very easy decision to make, let alone execute.
Last March, the last time they released quarterly U.S. economic forecasts, most officials expected to keep the Fed’s benchmark interest rate near zero until 2023, and officials believed that consumer prices would rise 2.4% in the fourth quarter of 2021 from a year earlier.
However, since the last meeting inflation has been accelerating and economy has rebounded much faster than anticipated, while companies have struggled to hire workers and raw material shortages have been affecting supply chains.
For a clear context of what the Fed should be looking at this week, the consumer price index released by the Labor Department rose 5% in May from a year earlier, following a 4.2% increase in the 12 months to April.
Is Not to Easy Change the Monetary Policy in the U.S.
It is not secret that increasing interest rates has always been a useful tool to help curb inflation, however, in this case it would have an unattractive effect on businesses and those trying to recover from the effects of the pandemic.
This decision would then make credit more expensive, as well as payments, mortgages, and in general all bills that need to be paid, which would then lead to households being left with less disposable income at a time when economic recovery is the main focus.
Federal Reserve Chairman, Jerome Powell, has stressed days ago that the central bank will begin to reduce the pace of its bond purchases “well before” raising interest rates.
Currently, the Fed has been buying about $120 billion a month of Treasury debt and mortgage-backed securities since last June to keep long-term borrowing costs low.
Although the Fed’s approach has always been that the economy must make “substantial progress” toward its goals of maximum employment and 2% inflation before reducing those purchases, neither condition is currently being met.
For his part, Jerome Powell reiterated that he believes it is highly unlikely that the Fed will raise interest rates this year and noted that most central bank officials see rates staying near zero until 2023.
How Does This Affect Investors?
If there were to be an increase in interest rates this week, which in this writer’s opinion is unlikely, every sector of the market would be instantly affected by it.
At the equity market level the impact would be of little benefit, as it would be considered a high risk market due to the increase in the value of the debt that companies hold.
However, one sector that would benefit would be the financial industry, the banks, the mortgage companies, and the insurance companies, among others, since they would be able to charge more money for the loans.
Meanwhile, at the bond level there is an inverse relationship of prices and interest rates, meaning that if interest rates rise, bond prices fall.
As interest rates rise, the cost of borrowing becomes more expensive. This means that the demand for low-yielding bonds will fall, causing their price to fall.
Currently, the value of the 10-year Treasury bond rate is 1.61%, well above the 0.9% it managed at the start of 2021, and a far cry from the 0.6% it held when the pandemic began.
At the currency market level, this news would have an immediate effect on the dollar.
If the central bank increases its interest rate, the value of the greenback would rise.
The dollar should then appreciate strongly against its main rivals such as the euro, as this decision would attract new investment capital.
On the other hand, if the Fed does not raise interest rates on Wednesday, the markets will punish the U.S. currency, but the extent of this will depend on the tone of the rest of the statement the central bank sends to the markets.
Do you think the Federal Reserve will raise interest rates or not? leave us your comments.