Markets and investors all over the world are keeping an eye on the most important event this month, July Double Campaign, where the decision of hiking interest rate by Fed and ECB will be realized during this month.
When the economy is growing quickly, central banks use the interest rate to control their monetary policy. By hiking interest rate, the supply of money decreases as the cost of money increases, which leads the individuals and businesses to reduce their spending of money.
Increasing interest rate leads to appreciation of the currency against others, which would affect the global investment opportunities, such as stocks, commodities and credit markets.
If the Fed or ECB decided to hike the interest rate, investors would invest in USD and EUR; therefor, USD and EUR will rise against other currencies, the prices of other investments will decline as the demand for USD and EUR increases. The supply of other investments such as indices, metals, futures, and shares would increase as well.
Hiking interest rate would increase the cost of borrowing money. Cash inflows and profits of companies will be affected in the long run as they will reduce their borrowing and spending which will reduce the company stock’s prices. Moreover, as a result of declining in companies cash inflows or declining in the profits, the whole market or the prices of major indices such as DJ, S&P as well as other indices will probably drop. Furthermore, investing in equities is riskier than other investments.
On the other hand, financial and banking sector can benefit from hiking interest rate as they can charge more for lending.
For commodity market, if the USD appreciated, the cost of imports by the foreign countries would be high as they should pay more by their currencies, which leads to the destruction of the goods. As a result, the prices of the commodities will fall.
The things which make this event interesting is that in June 27th, EUR rose sharply against USD after Mario Draghi said that ECB will remove the monetary stimulus soon as the economy in Eurozone is recovering, also hinted that ECB might hike the interest rate soon but not before they remove QE program.
Moreover, FED started to increase the interest rate for the first time since 2008 this year. On July 12th, Federal Reserve Chairwomen Janet Yellen indicated that the interest rate would be increased gradually till the inflation reaches the target level. Furthermore, on Wednesday 12th of July, Federal Reserve Chair Janet Yellen testified in front of congress and answered their questions regarding the Fed’s monetary policy. In the testimony, Yellen reaffirmed the Fed position for another hike this year while stressing that recent slack in inflation has raised some concerns for some Fed members; thus, the Federal reserve would have a close and cautious eye on the upcoming Inflation data. Yellen also indicated that the federal reserve would start smoothing their balance sheet regardless of low inflation levels.
Yellen’s testimony raised concerns among investors regarding the United states inflation growth as this can be seen with recent drop in the dollar versus global currencies. Adding to the negative sentiment of investors is the downbeat recent inflation data released after Yellen’s testimony on Friday, the data shows that inflation in U.S fell to 1.6% in June compared to a reading of 1.9% in May. Meanwhile, retail sales also showed downbeat results for the second consecutive reading. Retail sales fell by 0.2% missing analyst’s forecasts of a 0.2% increase; thus, suggesting a drop in consumer spending. Consequently, raising questions on the current stance of the Fed that seems to set on further rate hike according to Fed Chair Janet Yellen testimony.
Despite recent slack in inflation and consumer spending, the market is expecting another hike this year; however, if inflation does not pickup analysts doubt, the Fed will continue their tightening agenda.