Popular
What is the Wassenaar Arrangement?
Recognizing Gaslighting
What is China’s ‘Wolf Warrior’ Diplomacy?
Latest on Tunisia and Arab Spring
What are VPNs, and why are they in the news always?
Few terms coming up in focus to understand the troubled global economy
U.S. Fed interest rate hike and its impact on India
Dispute between Armenia and Azerbaijan – The past and the present 
Why are special drawing rights (SDR) in the news always?
The world faces a growing stagflationary storm
Politics Science News
  • Home
  • Topics
    • Economics Environment Global Reports/Agreements In pictures Intl. Organisations Personalities Politics Science & Tech Theory / Facts World World History All
      Economics

      Few terms coming up in focus to understand…

      29th July 2022

      Economics

      Why are special drawing rights (SDR) in the…

      23rd May 2022

      Economics

      The world faces a growing stagflationary storm

      5th May 2022

      Economics

      What is and Why De-Dollarisation?

      22nd April 2022

      Economics

      Explained – The U.S. Federal Reserve to increase…

      8th February 2022

      Economics

      All you need to know about the Natural…

      24th January 2022

      Economics

      The Truth about “Tax the Rich”

      27th December 2021

      Economics

      Venezuela Crisis

      2nd October 2021

      Environment

      World Air Quality Report 

      28th March 2022

      Environment

      Why should we be worried about topsoil erosion?

      21st March 2022

      Environment

      Effects of Climate Change

      30th July 2021

      Environment

      Implications of a Tragic Love Story – Coral…

      4th June 2021

      Global Reports/Agreements

      IPCC Report 2022

      8th March 2022

      Global Reports/Agreements

      The Climate Change Negotiations – UNFCCC and Paris…

      3rd August 2021

      Global Reports/Agreements

      Understanding World Happiness Report

      15th April 2021

      In pictures

      World War 2 Summary (1939 to 1945)

      9th July 2020

      In pictures

      World War I – 1914-1918

      30th June 2020

      Intl. Organisations

      What is the Wassenaar Arrangement?

      5th January 2023

      Intl. Organisations

      International Energy Agency (IEA)

      15th April 2022

      Intl. Organisations

      Food and Agriculture Organization (FAO)

      12th April 2022

      Intl. Organisations

      United Nations Human Rights Council (UNHRC)

      10th April 2022

      Intl. Organisations

      What is the G20 Summit?

      31st October 2021

      Intl. Organisations

      What is QUAD? | Quadrilateral Security Dialogue

      10th October 2021

      Intl. Organisations

      SCO – What is Shanghai Cooperation Organisation?

      28th September 2021

      Intl. Organisations

      G7 GROUP

      24th September 2021

      Personalities

      Gramsci Prison Notebooks

      18th November 2021

      Personalities

      John Stuart Mill: Theories

      10th September 2021

      Personalities

      Understanding Rousseau, Jean-Jacques

      4th July 2021

      Personalities

      John Locke – Father of Liberalism

      14th June 2021

      Personalities

      Hobbes Leviathan – Political Philosophy of Hobbes

      22nd May 2021

      Personalities

      Chanakya Strategies in administration

      30th March 2021

      Personalities

      Who was Machiavelli? – The Prince Summary and…

      3rd March 2021

      Personalities

      Aristotle – A Greek Philosopher

      25th January 2021

      Politics

      What is China’s ‘Wolf Warrior’ Diplomacy?

      21st October 2022

      Politics

      Latest on Tunisia and Arab Spring

      18th August 2022

      Politics

      Dispute between Armenia and Azerbaijan – The past…

      27th May 2022

      Politics

      Sudan’s Nightmare: The Conflict Explained

      9th January 2022

      Politics

      What’s happening between Ukraine and Russia?

      12th December 2021

      Politics

      China Taiwan Conflict

      7th October 2021

      Politics

      Taliban taking over Afghanistan

      18th August 2021

      Politics

      Armenian Genocide – What Happened?

      24th April 2021

      Science & Tech

      What are VPNs, and why are they in…

      29th July 2022

      Science & Tech

      Does Splinternet mean the end of the Internet?

      6th April 2022

      Science & Tech

      What you must know about the world’s first…

      2nd January 2022

      Science & Tech

      Omicron: Everything you need to know about COVID-19…

      5th December 2021

      Science & Tech

      Dopamine Happy Hormone

      14th August 2021

      Science & Tech

      How to avoid trans fat?

      7th August 2021

      Science & Tech

      Mental Health during the COVID19 pandemic 

      27th June 2021

      Science & Tech

      CRISPR Nobel Prize 2020 – What is it…

      27th December 2020

      Theory / Facts

      What is Fascism?

      21st July 2021

      Theory / Facts

      Banality of Evil

      14th July 2021

      Theory / Facts

      Evolution of Western Political Thought

      19th December 2020

      Theory / Facts

      What is Game Theory in Politics?

      10th December 2020

      Theory / Facts

      Demarcation of Powers and Responsibilities

      13th September 2019

      Theory / Facts

      Realist vs Idealist

      2nd September 2019

      World

      The Truth about Chernobyl Nuclear Disaster

      28th February 2022

      World

      Djokovic Visa Controversy – More Than What Meets…

      17th January 2022

      World

      Happiest Countries in the World – Top 10

      5th April 2021

      World

      5 Women making history in 2021 – Women…

      21st March 2021

      World

      Five demonstrations that changed history

      5th February 2021

      World

      Myanmar Story

      2nd February 2021

      World

      India and Global Nuclear Order

      31st January 2021

      World

      Nuclear Proliferation

      30th January 2021

      World History

      Israel Palestine Conflict

      11th May 2021

      World History

      What is Cold War? – Cold War Summary

      11th February 2021

      World History

      Russian Revolution

      10th January 2021

      World History

      The Soviet Union Collapse and End of Cold…

      30th December 2020

      World History

      French Revolution – What happened?

      3rd December 2020

      World History

      American Revolution Summary

      28th November 2020

      World History

      South Korea vs North Korea

      12th September 2020

      World History

      World War 2 Summary (1939 to 1945)

      9th July 2020

      Topics

      What is the Wassenaar Arrangement?

      5th January 2023

      Topics

      What is China’s ‘Wolf Warrior’ Diplomacy?

      21st October 2022

      Topics

      Latest on Tunisia and Arab Spring

      18th August 2022

      Topics

      What are VPNs, and why are they in…

      29th July 2022

      Topics

      Few terms coming up in focus to understand…

      29th July 2022

      Topics

      Dispute between Armenia and Azerbaijan – The past…

      27th May 2022

      Topics

      Why are special drawing rights (SDR) in the…

      23rd May 2022

      Topics

      The world faces a growing stagflationary storm

      5th May 2022

  • NewsFeed
  • Miscellaneous
  • Videos
  • Archives
Economics

Explained – The U.S. Federal Reserve to increase interest rates

by Admin 8th February 2022
8th February 2022
increase interest rates

Why does the Fed cut interest rates when the economy begins to struggle—or raise them when it is booming?  In the aftermath of the 2008 Financial Crisis, the Federal Reserve (central bank of the U.S.) reduced interest rates to zero. The idea was to increase investments and consumer spending and pull the American economy out of recession. But how?

The theory is that by lowering interest rates, borrowing becomes easier, which prompts companies to borrow, hire more people, and increase production. The logic works in reverse too. As interest rates rise, people are less likely to borrow or refinance existing debts because it is more expensive to do so.

The central bank cut rates to close to zero when the coronavirus pandemic hit the U.S. in March 2020. Now the U.S. job market is nearly healthy enough that the central bank’s low-interest-rate policies are no longer needed, Federal Reserve officials concluded. The United States also faces high inflation as a result of post pandemic recovery, which means that the prices people pay for goods and services continue to rise. Now higher interests will also keep a check on rising inflation by decreasing the money supply in the market as more cash will be held in bank accounts and less will be spent. It will lower money supply which will lead to lesser demand for goods in the market. Lower demand for goods will make them cheaper, lowering inflation.

Therefore, the U.S. Federal Reserve has signalled a possible hike in interest rates. Higher interest rates that will further decrease the money supply as lending and credit markets contract. From bank loans to mortgages, it will become more expensive to borrow. Hence, an increase in the cost of capital can hinder consumption, manufacturing, and production. 

But it has led to a nervous reaction in other emerging economies. Because the United States has the world’s largest economy, every economic move the country makes has an immediate impact on global markets. It will have some influence on the policies of other emerging economies.

Rising interest rates will strengthen the U.S. dollar, making it more expensive for emerging market countries that have borrowed heavily in the currency to service their debts. Read below to understand fully how this happens.

Impact of increased interest rates on emerging economies

Emerging economies such as India tend to have higher inflation (due to rapid economic growth) and higher interest rates than those in developed countries such as the United States and many of the (primarily Western) European nations. As a result, financial institutions would prefer to borrow money in the U.S. at low-interest rates in dollar terms and then invest that money in government bonds of emerging countries such as India in local currency terms to earn a higher rate of interest.

When the U.S. Federal raises its domestic interest rates, the difference between the interest rates of the two countries decreases. It makes emerging economies less attractive, and, consequently, some of the money may be expected to move out of the markets and flow back to the U.S. Also, Treasury bonds (bonds issued by the USA government) are considered a risk-free asset. With interest rates expected to increase, it causes global investors to park their money in the U.S. Therefore decreasing the value of developing country’s currency against the U.S. dollar. Ultimately, this can harm exchange rates and exports, along with employment levels in developing nations.

Dollar currency-denominated debt outside the United States is huge as well. In situations where U.S. interest rates increase while the dollar appreciates, the exchange rate between developing nations and the U.S. tends to widen. As a result, dollar-denominated debt owed by developing nations increases and becomes unmanageable.

The Commodities Market is also affected. Oil, gold, cotton and other global commodities are priced in U.S. dollars, and a strong currency following a rate increase would increase the price of commodities for non-dollar holders.

Impact on Bond Yields

What are bond yields? As companies/governments issue bonds, an investor buys and in turn, companies/governments raise money/or capital to carry on their activities. They pay a fixed interest to the bondholders, popularly known as the coupon rate. The coupon rate is declared upfront and remains fixed until maturity. Upon maturity, bondholders get their invested money back. 

Bondholders are essentially lending money to the bond issuers. In return, bond investors receive their principal—initial investment—back when the bonds mature and also receives periodic interest payments. The second way a bondholder can earn income from holding a bond is by selling it on the secondary market (exchanges). If a bondholder sells the bond before maturity, there’s potential to gain on the sale. Like shares, bonds can increase in value. The returns bondholders get on trading bonds are called bond yields. 

The bond yield will depend on the bond’s price if purchased/sold from the secondary market (exchanges). Basically, a bond yield is a return an investor realises on that bond after being traded on exchanges. Like other securities, their prices rise and fall with supply and demand.

For example, if the coupon rate of a 10-year bond of the face value of $1,000 is 6 per cent, the company/government will pay interest of $60 every year for the investment period of 10 years. If the bond price with the face value of $1,000 falls to $600 in the secondary market, it will still fetch the interest of $60 per year per bond, resulting in an increase in yield to 10 per cent for the bondholder.

It is the first cardinal rule to remember about bonds: As bond prices increase, bond yields fall. Let’s say you have a $1,000 bond that has an annual coupon payment of $100, and it’s selling near par for $1,010 on an exchange. Its yield is 9.9% ($100 / 1010). Now, let’s say the bond’s price jumps to $1,210. Its yield falls to 8.3% (100 / 1210). Lesser the yield more the profit for the bondholder.

So, what makes bond prices move? Several things, but a key one is prevailing interest rates. And this is the second cardinal rule to remember about bonds: When interest rates are low, bond prices increase—because investors seek a better return. Say the Federal Reserve slashes the federal funds rate from 3% to 1% (interest rate). If there’s a bond trading on the market that’s paying 4%, that’s suddenly going to be a lot, and everyone’s going to want it. So, due to supply and demand, its price will go up. And because one is paying more for it, its yield becomes less—the increased demand for the bond results in rising prices—and falling yields.

The situation is reversed when interest rates rise. When the risk-free rate of return (like what you find in U.S. Treasury bonds and bills) rises, money moves from financial assets to the safety of guaranteed returns. For example, if the interest rate increases from 2% to 4%, a bond yielding 5% on exchange would become less attractive. The extra yield would not be worth taking on the risk. Demand for the tradeable bond would decline, and the yield would rise.

 increase interest rates
Increase Interest Rates

Indian banks, particularly public sector banks, are among the country’s major bondholders. Bond losses are a key issue for banks since rising interest rates cause bond values to decline (or yield increase), resulting in losses that the banks must book. It might lower bank earnings. Therefore, the banks are expected to raise the rates paid out on deposits to keep them attractive. To compensate for that, they are forced to raise the lending rates to maintain their interest rate spread.

Thus, companies may be forced to borrow at higher rates of interest, which will impact their projects and ultimately on the profits.

A rise in bond yields will put pressure on interest rates in the banking system, leading to a hike in lending rates.

Whenever the bond yield increases, investors prefer to withdraw from equities and look at investing in U.S. bonds. It raises the cost of capital for companies, which, in turn, affects their stock valuations. Hence, stock markets worldwide are seeing some impact of increasing bond yields.

Impact On Export and Forex

Taking an example of India – India is one of the largest crude oil importers in the world. A weaker rupee vis-à-vis a dollar results in more expensive imports of crude oil that may result in inflationary push across the whole economy, especially in sectors that are highly sensitive to crude oil price movements. 

increase interest rates
Increase Interest Rates

Consider an electronic component that costs $10 in the United States and will be exported to India. Assuming a 50-rupee-to-dollar exchange rate, the $10 electronic component would cost the Indian importer 500 rupees. If the dollar strengthened against the Indian rupee to a level of 55 rupees (to one U.S. dollar), the price for the Indian importer would rise to 550 rupees ($10 x 55).

In contrast, India’s exports, particularly I.T. and IT-enabled services, will benefit to some extent from a stronger dollar relative to the rupee. They are paid in dollars for their services, and as the dollar strengthens against the domestic currency, they profit more. However, due to intense competition in the export market, the same benefit may not be fully realised by exporters.

Overall, the Federal Reserve’s action will hamper Asia’s economic recovery.

previous post
Know Your Wine – The Ultimate Basic Guide For All
next post
Know Your Wine – A Wine Tasting Guide

Related Articles

Few terms coming up in focus to understand...

29th July 2022

Why are special drawing rights (SDR) in the...

23rd May 2022

The world faces a growing stagflationary storm

5th May 2022

What is and Why De-Dollarisation?

22nd April 2022

All you need to know about the Natural...

24th January 2022

The Truth about “Tax the Rich”

27th December 2021

Venezuela Crisis

2nd October 2021

What is Bitcoin?

17th February 2021

GST explained with examples – Goods and Services...

3rd January 2021

Currency Wars ( beggar-thy-neighbour policy )

12th September 2019

Recent Posts

  • What is the Wassenaar Arrangement?

    5th January 2023
  • Recognizing Gaslighting

    10th December 2022
  • What is China’s ‘Wolf Warrior’ Diplomacy?

    21st October 2022
  • Latest on Tunisia and Arab Spring

    18th August 2022
  • What are VPNs, and why are they in the news always?

    29th July 2022

Subscribe Newsletter

Subscribe my Newsletter for new blog posts, tips & new photos. Let's stay updated!

NewsFeed

  • After 50,000 years, a ‘green comet’ will approach the planet

    27th January 2023
  • 2023 UN World Social Report

    20th January 2023
  • Global Risk Report 2023

    16th January 2023
  • What is a recession?

    13th January 2023
  • Tokyo is crowded that the government is paying families to relocate

    10th January 2023
  • Green Hydrogen Explained

    7th January 2023
  • Why is Ozempic trending on TikTok?

    4th January 2023
  • Watch out for these five space exploration missions in 2023

    1st January 2023
  • Know about recession and the yield curve

    29th December 2022
  • Artificial intelligence tool called ChatGPT 

    27th December 2022

Article Archives

Editor’s Picks

  • International Organisations List

    7th October 2020

Social Counter

facebook Like
instagram Follow Us

Popular Posts

  • 1

    World Economic Forum (WEF)

    27th January 2021
  • 2

    China Taiwan Conflict

    7th October 2021
  • 3

    European Union

    20th October 2019
  • 4

    Sunni and Shia Differences and ISIS Conflict

    1st October 2019
  • 5

    Armenia-Azerbaijan Conflict

    9th October 2020

Posts Slider

What is the Wassenaar Arrangement?

5th January 2023

Recognizing Gaslighting

10th December 2022

What is China’s ‘Wolf Warrior’ Diplomacy?

21st October 2022

Latest on Tunisia and Arab Spring

18th August 2022

What are VPNs, and why are they in...

29th July 2022

Few terms coming up in focus to understand...

29th July 2022

U.S. Fed interest rate hike and its impact...

17th June 2022

Dispute between Armenia and Azerbaijan – The past...

27th May 2022

Why are special drawing rights (SDR) in the...

23rd May 2022

The world faces a growing stagflationary storm

5th May 2022

What is and Why De-Dollarisation?

22nd April 2022

International Energy Agency (IEA)

15th April 2022

Food and Agriculture Organization (FAO)

12th April 2022

United Nations Human Rights Council (UNHRC)

10th April 2022

Does Splinternet mean the end of the Internet?

6th April 2022

Quote

"unexamined life is not worth living" - SOCRATES

"law is a reason free from passions"- ARISTOTLE

"he who wishes to be obeyed must know how to command"- MACHIAVELLI

"be kind, for everyone you meet is fighting a hard battle"- PLATO

"prepare for the worst; expect the best; and take what comes"- HANNAH ARENDT

"he who knows only his own side of the case knows little of that"- J S MILL

  • Facebook
  • Instagram
  • Youtube
  • Topics
  • NEWSFEED
  • Videos
  • Miscellaneous
  • Contact
  • Privacy Policy

@2022 All Right Reserved

Politics Science News
  • Home
  • Topics
    • Economics Environment Global Reports/Agreements In pictures Intl. Organisations Personalities Politics Science & Tech Theory / Facts World World History All
      Economics

      Few terms coming up in focus to understand…

      29th July 2022

      Economics

      Why are special drawing rights (SDR) in the…

      23rd May 2022

      Economics

      The world faces a growing stagflationary storm

      5th May 2022

      Economics

      What is and Why De-Dollarisation?

      22nd April 2022

      Economics

      Explained – The U.S. Federal Reserve to increase…

      8th February 2022

      Economics

      All you need to know about the Natural…

      24th January 2022

      Economics

      The Truth about “Tax the Rich”

      27th December 2021

      Economics

      Venezuela Crisis

      2nd October 2021

      Environment

      World Air Quality Report 

      28th March 2022

      Environment

      Why should we be worried about topsoil erosion?

      21st March 2022

      Environment

      Effects of Climate Change

      30th July 2021

      Environment

      Implications of a Tragic Love Story – Coral…

      4th June 2021

      Global Reports/Agreements

      IPCC Report 2022

      8th March 2022

      Global Reports/Agreements

      The Climate Change Negotiations – UNFCCC and Paris…

      3rd August 2021

      Global Reports/Agreements

      Understanding World Happiness Report

      15th April 2021

      In pictures

      World War 2 Summary (1939 to 1945)

      9th July 2020

      In pictures

      World War I – 1914-1918

      30th June 2020

      Intl. Organisations

      What is the Wassenaar Arrangement?

      5th January 2023

      Intl. Organisations

      International Energy Agency (IEA)

      15th April 2022

      Intl. Organisations

      Food and Agriculture Organization (FAO)

      12th April 2022

      Intl. Organisations

      United Nations Human Rights Council (UNHRC)

      10th April 2022

      Intl. Organisations

      What is the G20 Summit?

      31st October 2021

      Intl. Organisations

      What is QUAD? | Quadrilateral Security Dialogue

      10th October 2021

      Intl. Organisations

      SCO – What is Shanghai Cooperation Organisation?

      28th September 2021

      Intl. Organisations

      G7 GROUP

      24th September 2021

      Personalities

      Gramsci Prison Notebooks

      18th November 2021

      Personalities

      John Stuart Mill: Theories

      10th September 2021

      Personalities

      Understanding Rousseau, Jean-Jacques

      4th July 2021

      Personalities

      John Locke – Father of Liberalism

      14th June 2021

      Personalities

      Hobbes Leviathan – Political Philosophy of Hobbes

      22nd May 2021

      Personalities

      Chanakya Strategies in administration

      30th March 2021

      Personalities

      Who was Machiavelli? – The Prince Summary and…

      3rd March 2021

      Personalities

      Aristotle – A Greek Philosopher

      25th January 2021

      Politics

      What is China’s ‘Wolf Warrior’ Diplomacy?

      21st October 2022

      Politics

      Latest on Tunisia and Arab Spring

      18th August 2022

      Politics

      Dispute between Armenia and Azerbaijan – The past…

      27th May 2022

      Politics

      Sudan’s Nightmare: The Conflict Explained

      9th January 2022

      Politics

      What’s happening between Ukraine and Russia?

      12th December 2021

      Politics

      China Taiwan Conflict

      7th October 2021

      Politics

      Taliban taking over Afghanistan

      18th August 2021

      Politics

      Armenian Genocide – What Happened?

      24th April 2021

      Science & Tech

      What are VPNs, and why are they in…

      29th July 2022

      Science & Tech

      Does Splinternet mean the end of the Internet?

      6th April 2022

      Science & Tech

      What you must know about the world’s first…

      2nd January 2022

      Science & Tech

      Omicron: Everything you need to know about COVID-19…

      5th December 2021

      Science & Tech

      Dopamine Happy Hormone

      14th August 2021

      Science & Tech

      How to avoid trans fat?

      7th August 2021

      Science & Tech

      Mental Health during the COVID19 pandemic 

      27th June 2021

      Science & Tech

      CRISPR Nobel Prize 2020 – What is it…

      27th December 2020

      Theory / Facts

      What is Fascism?

      21st July 2021

      Theory / Facts

      Banality of Evil

      14th July 2021

      Theory / Facts

      Evolution of Western Political Thought

      19th December 2020

      Theory / Facts

      What is Game Theory in Politics?

      10th December 2020

      Theory / Facts

      Demarcation of Powers and Responsibilities

      13th September 2019

      Theory / Facts

      Realist vs Idealist

      2nd September 2019

      World

      The Truth about Chernobyl Nuclear Disaster

      28th February 2022

      World

      Djokovic Visa Controversy – More Than What Meets…

      17th January 2022

      World

      Happiest Countries in the World – Top 10

      5th April 2021

      World

      5 Women making history in 2021 – Women…

      21st March 2021

      World

      Five demonstrations that changed history

      5th February 2021

      World

      Myanmar Story

      2nd February 2021

      World

      India and Global Nuclear Order

      31st January 2021

      World

      Nuclear Proliferation

      30th January 2021

      World History

      Israel Palestine Conflict

      11th May 2021

      World History

      What is Cold War? – Cold War Summary

      11th February 2021

      World History

      Russian Revolution

      10th January 2021

      World History

      The Soviet Union Collapse and End of Cold…

      30th December 2020

      World History

      French Revolution – What happened?

      3rd December 2020

      World History

      American Revolution Summary

      28th November 2020

      World History

      South Korea vs North Korea

      12th September 2020

      World History

      World War 2 Summary (1939 to 1945)

      9th July 2020

      Topics

      What is the Wassenaar Arrangement?

      5th January 2023

      Topics

      What is China’s ‘Wolf Warrior’ Diplomacy?

      21st October 2022

      Topics

      Latest on Tunisia and Arab Spring

      18th August 2022

      Topics

      What are VPNs, and why are they in…

      29th July 2022

      Topics

      Few terms coming up in focus to understand…

      29th July 2022

      Topics

      Dispute between Armenia and Azerbaijan – The past…

      27th May 2022

      Topics

      Why are special drawing rights (SDR) in the…

      23rd May 2022

      Topics

      The world faces a growing stagflationary storm

      5th May 2022

  • NewsFeed
  • Miscellaneous
  • Videos
  • Archives