Trends in the Economy

Yeh Kahaani Fed Ki: Rate hike?

The most awaited event of the year, the two-day rate-setting meeting of the Federal Open Market Committee that starts on December 15th   is just few days away.

What makes it extra special is the fact that the possibility of an interest rate hike, that has remained the subject of rumor mills for the last six months, may finally shape into reality in this much awaited last Fed meeting of the year. If we go through the developments in second half of 2015, it becomes quite clear that the probability of a rate hike is on the cards. Let us analyze the key points which have been under Janet Yellen’s scanner for long time:

Overall growth in US: The US economy, which was in deep crisis during 2008-2009, has very well responded to the policies framed by US Fed in later years. Be it the bailout packages or their subsequent withdrawal, the US economy showed enough maturity and went from strength to strength in years to come. The employment situation has considerably improved in US, thanks to a new force of skilled labors getting jobs in new enterprises and startups. The crucial ‘jobless claims data’ has continuously shown improvement and has remained below 300K for more than 40 weeks now while the closely watched non-farm payrolls are also showing strength. Janet Yellen has always expressed that the way to an interest rate hike scenario will depend on strong economic data in major sectors. Thus, if we scan major economic parameters in last few months then we can see that it is not only employment sector which has shown improvement; the industrial production, manufacturing & GDP numbers have also responded equally. So after looking at exciting numbers from economic data, one can say that the high interest days are not far in US if Fed considers growth in US as the sole parameter for taking such decision.

Situation in major economies: Most of the major world economies, barring India and China, found it hard to bear the brunt of global crisis in 2008-2009. However, US begun to show signs of improvement in late 2010 but Euro zone problems continued to deepen. In next couple of years, Japan too succumbed to the downfall and recently we saw how China’s growth bubble burst. All in all, the recovery and growth phase has remained limited to US and if we consider India as a major player then one can conclude that neither downfall nor growth has come in its full swing to India till 2014. No doubt, things have improved in India in recent months and the ground work done by new government will start yielding results. Still, if US Fed remembers IMF’s warning to not consider a rate hike at least till mid 2016, then it has enough ground to skip a hike till next end of quarter. Alternatively, the Fed can also adopt a mid-way by hiking interest rate in this meeting BUT keeping the language for future outlook very hard. In both situations, the US Dollar will get significant benefit. Chances are that the US Fed will give less importance to situation in major economies in this particular meeting since the decision to hike interest rate has now become long due.

Crude oil prices: Crude oil drives world economy and impacts every aspect of micro and macro economics. One reason for interest rate hike being kept pending for long time may be the US’ keen desire to get an edge over OPEC in world’s crude oil share. The year-long down trend in crude oil reached a situation of ‘sharp free fall’ a couple of months back and if we consider OPEC’s determination to not go for a production cut anytime soon, the downfall in prices will deepen BUT will also find takers as we are already in an under $37 per barrel price range and not in a $50 or $60 times. The US Fed may have been waiting for this situation as the rate hike will prompt another spell of sharp fall but quickly arrest it through high demand from Asian giants India and China which have benefited most from the low priced fuel. The inventory glut will ultimately act as advantage for US as and when trend in crude oil reverses. To conclude, it is a calculated risk on part of US Fed and a very well thought strategy to keep a hold on world economy.

NOW THE BIG QUESTION: what will be the impact on commodities?
Commodities will witness a mixed impact if US Fed hikes interest rate. First of all, commodity prices will initially trend against US Dollar and may thus get their downfall extended for some time. Fundamentals will surely play a vital role once this ‘quick reaction’ period ends. Following are the segment-wise possible impact:

Bullion: Gold will extend its southward journey; as the prices are already in a long term primary bearish trend, we may see the interest rate hike impact extending to a couple of years more. Prices may touch a lower range of $950-$900 in next one year, thus making the yellow metal a loser in this game of interest rates.

Silver will also follow the footsteps of its elder sibling BUT we may see white metal finding support after a ‘quick reaction’ crash in response to a possible rate hike by US Fed. Fundamentally, the rate hike will on one hand force traders to liquidate positions on assets other than dollar while on the other hand, the same will benefit prices in long term as industrial demand will rise. Silver is likely to find strong support at $11 after another spell of heavy selling.

Crude Oil: Crude oil may break below its crucial support of $32 and may extend the fall in the range of $28-$25 in early 2016. Prices are likely to reverse once industrial & manufacturing growth resurrects. It is clear that still a big chunk of bearish trend is remaining and buying will come only after prudent growth outside US or if OPEC decides to end the tussle with US by going for a production cut. However, things at production scenario and the cut-throat competition are like wheels within wheels.

Base Metals: Base metals like copper & nickel will face the worst situation in case of a rate hike by US Fed as fundamentals in the largest buyer China doesn’t seem to improve in near time. Aluminium, zinc and lead will also see some selling pressure but will find takers as they are better on fundamental level. In long term, say two years, if things improve in China and the US continues to show strong growth, the rate hike will actually benefit the segment.

(Image source)

Arihant Team
The Arihant Team believes everyone deserves access to sophisticated financial advice. From day one, our mission has been to help make investing easier and accessible to every Indian. Our team of experts are curating informative and research-based article on this blog, to help make investing and managing your money easier for you!

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