US interest rate hike: what does it mean for investors?

The Fed has raised interest rates by 75 basis points (+0.75%), lifting target interest rate to 3.00%-3.25% range. Six months ago, when it was 0.00% to 0.25%, banks could borrow money almost free from the central, that is no longer the case.

This is the fifth rate hike in six months. The reason the Federal Reserve does that is simple: to control inflation. Prices are skyrocketing and life is getting more and more expensive. This spiral must be broken.

At the beginning of this year, the US central bank still thought inflation was temporary. But the price increases are clearly much more persistent. The war in Ukraine has exacerbated the situation. Gas, oil and agricultural commodities have also become scarcer and more expensive as a result.

Interest rate hikes make borrowing more expensive. We are then less inclined to borrow money for investment and consumption. Also demand from businesses therefore decreases, which can cause prices to fall. Inflation should not exceed 2%. However, it is currently about 10% in Europe and almost 9% in the United States. So there is still a long way to go and we can expect a series of rate hikes, both in the US and in Europe.

What exactly does this mean for savers and investors? American savers will finally be reimbursed for the money in their savings account. Maybe they are happy. But there is no reason for exuberance. If you get roughly 3% interest on your savings while inflation is 8%, then the real value of your savings is still declining!

In Europe, savers still receive only 0.1% interest on their savings. In a few months, that may become a bit more. But European savers will also continue to lose purchasing power this year and next. Because the central banks assume that inflation will only be brought back below 2% by 2025.

With government loans and government bonds you can get a higher interest than on a savings account. But then you have to lock up your money for roughly 8 to 10 years. As long as interest rates continue to rise, we don’t advise you to do that just yet.

The trick is to lend your money for such a long period of time when the interest rate reaches its peak. Then you will also receive that high interest for the next 8 to 10 years. It is impossible to determine that ideal moment in advance. Given that interest rates are still rising, we may not have reached that ideal moment yet. 2023 may be the ideal year for such a long-term investment in government bonds.

A rising interest rate is poison for stocks and the stock market. If borrowing becomes more expensive, companies make less profit and the economy can even enter a recession. So you should not expect a general stock market recovery at the moment.

Some companies will continue to do well. You can expect continued good results from companies active in the energy sector. Food companies with strong brands can also maintain their profits. We always have to eat and drink and we are attached to the brands with which we are familiar.

To respond to a general stock market recovery, you must continue to monitor what happens to interest rates. As soon as interest rates fall, the stock market can get off to a flying start and rise again for years. Since investors always look ahead, the stock market will even start to rise at the first signs that an interest rate cut is possible.

The dollar is the big winner of the US interest rate hikes. Since the interest in euros is much lower than in dollars, money is transferred worldwide to the American currency. The dollar has already risen about 20% against the other major currencies in the world this year. A further appreciation of the dollar is possible. But we wouldn’t expect too much from that. The dollar is at its highest level in 20 years. There doesn’t seem to be much additional upside potential.

Gold is widely regarded as a protection against inflation. That is only partially true. American investors who get 3% interest again on a savings account are less likely to buy gold, which yields 0% interest.

In this year of rising inflation, gold has already fallen in price by more than 8%, in dollars per ounce. As a European you do book more than 5% profit on gold. In euros, that is. Gold is therefore much more suitable as a hedge against a fall in the euro than against inflation. As a hedge against inflation, gold is only interesting if the central bank lets things run their course, as was the case in the 1970s.

Higher interest rates also put a brake on the real estate market. If borrowing becomes more expensive, there are fewer people who are still willing or able to borrow to buy real estate. If there are fewer potential buyers, prices will rise less quickly or even stop at all.

According to the believers, cryptos form a separate category, separate from other investments. That theory is currently being tested. If there is less cheap money in circulation, will cryptos maintain their price level? This year, almost all cryptos have already fallen sharply.

If the above resonates with you and you would like to discuss this more, please contact us: hello@expatfinancial.biz