How Will Rise in US Interest Rate Impact the Market?

The wait is not over yet while all the recent news points to a rate hike sooner rather than later. Most analysts believe that it will happen in year 2015 rather than 2016. The most recent prediction was for it to happen in September (see one of them by Richard Fisher, former president and chief executive of the Dallas Fed). What will likely to be the impacts of US rate hike, especially to the Stock Market in Malaysia and globally?

First, higher interest rates mean higher borrowing costs, lower asset prices, reduced risk-premium and a stronger greenback. All of these are relatively bad for the stock market. Higher discount rates mean lower stock prices, while reduced risk-premium makes equities less attractive compared to new issues of bonds. On the corporate side, higher interest rate will mean higher borrowing costs thus hurting indebted companies. A stronger dollar negatively affects the exporters and international businesses, which are a significant part of the U.S. stock market. So, it is believed that a rate hike will have adversed impact on the stock market.

The hike has also been priced to some extent into the U.S. dollar index, as the currency investors are future-oriented. Typically, the currency movements are the very leading indicator. Indeed, the history of the past three tightening cycles teaches us that the greenback gains in the six to nine months preceding the first interest rate hike over the cycle. As you can see from US Dollar Index (DXY) below, the index has seen continuous climb since Aug 2014, only to see minor correction (and possibly side-way) in anticipation of the rate hike very soon.

US Dollar Index

What are the impacts on gold market? It is widely anticipated that the Fed’s hike alone would not negatively affect gold prices. The real interest rates or U.S. dollar index are much more important for the gold market than single changes in the federal funds rate. Besides, there are other factors that may caused gold price to rise, for example on worries about the Eurozone economy, despite the Fed’s tightening.

So, in what direction will US Stock Market performs after the rate hike? In recent years US share prices have risen in large part because of expanding price to earnings ratios, which essentially means investors have been willing to pay increasingly more for shares in companies relative to their earnings. Following a period like that, investors will typically want to see more notable earnings growth if share prices are to go higher still. In general, market believes that a rate high will cause stock price to go down, it could be due to higher cost, higher inflation, and weakening market sentiment. Also, with the US market gone up so much over the years, it is highly likely that the fear will develop among investors that peak is over soon. Market will bound for some corrections.

On the local end, KLCI has seen downwards pressure due to outflow of fund, low oil price, weaker Ringgit, and also some other local factors. Based on historical data, a small, measured, and economic data-dependent rate hike by the Fed that have been previously telegraphed would not have a significant impact on Asian markets. Since the Fed started QE tapering last September, the potential rate hike has been one of the most anticipated moves and has likely already been priced into the markets. So, whether KLCI will see further decline after the rate hike will highly dependent on local factors such as the handling of household debts, the weakening currency, and also the handling of scandal such as the 1MDB.

 

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