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How US interest rate changes can affect your investments

5 minute read

Falling or rising interest rates in the world’s biggest economy have global implications, but what exactly do they mean for your investments?

Who's it for? Investors with basic investment knowledge

The value of investments can fall as well as rise and you could get back less than you invest. If you’re not sure about investing, seek professional independent advice.

What you’ll learn:

  • Why changing US interest rates affect your investments.
  • How current falling rates affect different stock markets and asset classes.
  • What impact US rate changes have on interest rates in the UK.

The Federal Reserve, the central bank of the United States, cut interest rates by 0.25% for the third time this year in October, amid continued concerns about slowing economic growth and global trade tensions.

In a move that was widely expected, the Fed cut interest rates by a further 25 basis points to target a range between 1.50% and 1.75%. This decision follows the revelation that in the third quarter of 2019 US economic growth slowed to 1.9%, which the slowest rate of expansion seen in 2019.1

On announcing the decision, which followed cuts in July and September, Fed chairman Jerome Powell implied the central bank would hold off on further cuts, stating “we believe that monetary policy is in a good place”.2

Here, we look at the how your savings and investments could be affected by changes to US interest rates.

Why does Federal Reserve policy matter?

You may be wondering just what impact changes to US interest rates may have on your investments, especially if you don’t have any money invested in US funds. Secondly, there is a much used phrase that reads: Where the Fed leads, the rest are forced to follow. This is because housing the largest economy, the deepest bond market and being the reserve currency of the world, the Fed's actions have a direct effect on many other countries.

However, interest rate changes are just one of a number of factors that influence market movements.

US and UK shares

The US has cut rates to stimulate the economy and to try to push inflation closer to the Federal Reserve’s target of 2%. Cutting rates helps boost economic activity by making it cheaper to borrow money for both businesses and consumers. In the immediate aftermath of the cut, the US stock market rallied, sending the S&P 500 index to close at a fresh record high of 3,047 points on 30 October.2

Rate moves tend to affect sectors in different ways. For example, when rates are rising, some company shares are able to thrive, with financials often tending to perform strongly.3 Banks may see their margins benefit from a rate rise. However, higher interest rates could place pressure on companies via higher funding costs.

The UK is also at some risk from economic storms in the US. The US is the largest single country export destination for the UK, accounting for about 13% of UK exports4 (although the UK exports much more to the countries of the EU taken together). If the US economy slows down, this could have an impact on the UK.

Emerging markets

US rate rises are generally seen as bad news for emerging market economies, which tend to have much of their debt denominated in US dollars. As such, the decision to cut rates will come as a relief to many emerging market countries.

When the Fed lowered interest rates back in 2008, borrowing in dollars became cheaper, with many emerging markets taking out loans to build new infrastructure and expand their economies. With lower interest rates came cheaper repayments.

Bonds

Investors have jumped into the safety of bonds, amid worries the global economy is slowing and that the trade wars will take a bigger toll on growth. Bond prices have generally been rising for 35 years. Given that bond yields tend to move in the opposite direction to prices, this has left yields very low, and quantitative easing programmes have magnified the trend. At the end of August, around a third of government bonds worldwide had a negative yield, guaranteeing a loss if held to maturity.

Government bonds look quite expensive to us as we think a lot of monetary policy easing and bad news has already been priced into the bond market.

In a period of falling interest rates, government bonds tend to offer more protection than other bonds because the rates on offer tend to be tightly linked to the health of the economy, so benefiting if interest rates get cut. They often also involve longer holding periods, which increases their sensitivity to interest rate changes.

Gold

Gold is perceived as a store of value, and typically loses its shine when interest rates climb. Following the decision to cut rates, the price of the yellow metal held near the key $1,500 per ounce level.5

Gold doesn’t pay any interest and is often perceived as a safe haven asset. As such it becomes less attractive as a store of value if interest rates increase or if economic growth picks up. If the US raises interest rates again, this could strengthen the US dollar. Gold is typically priced in dollars, and this will make it more expensive in terms of other currencies

Will rates fall in the UK too?

In November 2017, the Bank of England raised interest rates for the first time in 10 years, lifting rates from 0.25% to 0.5%.6 It then made a further quarter percentage point increase in August 2018, bringing the base rate to its current level of 0.75%. Despite predictions of more rises to follow, the level has stayed unchanged since and experts are now questioning if Britain will follow the path of US again in cutting rates.

Unlike the US, rate cuts are not being priced in by the market so far. Experts predict a very low probability of change at the next Monetary Policy Committee (MPC) meeting in November.7 However, if the UK leaves the European Union next January without a deal, economic growth could suffer and market expectation may then veer towards a rate cut.

Please remember that investments can fall as well as rise and you may get back less than you invested. Past performance is not a reliable indicator of future performance.

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