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How rising US interest rates affect investments

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

The value of investments can fall as well as rise; you may not get back what you invest. If you’re not sure about investing, seek independent advice. The past performance of investments is not a reliable indicator of their future performance.

What you’ll learn:

  • Why rising interest rates are considered bad news for stock markets.
  • How rate rises affect different sectors in different ways.
  • What impact US interest rates have on emerging markets.

The US Federal Reserve increased interest rates for the third time within the year in December, and predicted a series of further rises in 2018.

Rates rose by a quarter percentage point on 13 December, to a range of 1.25% to 1.5%, with chairman of the Fed Janet Yellen citing a “strong” jobs market and growth in household and business spending. She signalled a series that there would be a series of rate increases in 2018, with three further rises expected.1

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

US and UK equities

Whether or when further increases will take effect is subject to debate. Typically, rising interest rates are considered bad news for stock markets. They see the cost of borrowing increase for consumers and businesses, which reduces spending on goods and services. However, they are just one of a number of factors that influence market movements.

The US has increased rates off the back of improving economic conditions, which should create a positive environment for companies to profit.

When the Fed increases rates, it typically works to reduce inflationary pressure, and appreciate the dollar. However, the dollar weakened against other major currencies following the latest rise, including the euro, sterling and yen, after the Fed failed to signal a faster pace of rate hikes in the year ahead.2 A weakening dollar may impact returns for investors in UK companies that generate profits in dollars, reducing their earnings. Many listed on the FTSE 100, such as miners, oil companies and pharmaceuticals fall into this category.3

Rate rises tend to affect sectors in different ways. For example, some company shares are able to thrive in an environment of rising rates, with financials often tending to perform strongly. Banks may see their margins benefit from a rate rise.

However, any rise in US rates may see some shares suffer, such as technology and consumer discretionary stocks, with consumers and businesses having less spare cash to spend.

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.

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, and raising rates could make these loans more expensive.

Yet the MSCI emerging markets index rose after the Fed suggested that weak inflation may slow the pace of future interest rates rises.4 Any delay in further rate increases could support emerging market economies, but they are likely to fall further if the suggested three rate rises take effect in 2018.

Bonds

The global bond market suffered a sell off, with yields climbing across the board following the rate rise.5 Yields tend to move in the opposite direction to prices, and are predicted by experts to rise further in the coming months. The loss in value of tradable bonds is the result of investors fearing being locked into fixed returns that are eroded by higher prices.

However, whether this definitely signals the end of the bond market bull run is debatable, particularly while so much uncertainty continues to surround future US fiscal stimulus, and the pace of further rate increases.

Gold

Gold is perceived as a store of value, and typically loses its shine when interest rates climb. However, as the market had priced in the latest Fed rate rise, the precious metal held onto gains, hitting $1,255.6

Gold doesn’t pay any interest, and becomes less attractive as a store of value when higher interest rates indicate firm economic growth. If the US raises interest rates again, this is likely to further strengthen the US dollar. Gold is typically priced in dollars, and this will make it more expensive in terms of other currencies.

Will rates rise in the UK too?

UK interest rates have languished in the doldrums since March 2009, when they were cut to an historic low of 0.5%. They were further slashed to 0.25% in August 2016, leaving savers continuing to earn low interest on accounts,7 but benefiting many borrowers who have seen mortgage and loan rates fall.

Yet the Bank of England’s Monetary Policy Committee (MPC) voted to increase the base rate by a quarter of a percentage point in November 2017, to 0.5%.8

In recent years, the UK economy has tended to follow a similar path to that of the US. A rate rise across the pond strengthens the potential for a similar hike by the Bank of England.

The British economy has steadily recovered since the financial crisis of 2008, with the unemployment rate hitting a 42-year low in December 2017, reaching 4.3%.9

However, uncertainty over the course of Brexit negotiations, coupled with higher inflation driven by import costs, could put pressure on the economy. The International Monetary Fund (IMF) reduced its forecast for UK growth this year from 1.7% in October 2017 to 1.6% in December, and said it expects the economy to slow further in 2018, with growth predictions at 1.5%.10

Essentially, An uncertain domestic backdrop – with inflation still above target but consumer demand weakening – makes it all the more difficult to forecast the path of UK interest rates in 2018.

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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The value of investments can fall as well as rise. You may get back less than you invest. Tax rules can change and their effects on you will depend on your individual circumstances.

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