HomeOpinionUS Fed interest rate: One to rule them all

US Fed interest rate: One to rule them all


LAST week the United States Federal Reserve resolved to maintain its benchmark policy rate at 0,25%, but hinted that it would revise the rate sooner than expected after the latest US inflation figures exceeded expectations.

The Federal Funds Rate, or the Fed rate, is the interest rate at which banks and other depository institutions lend money to each other, usually on an overnight basis in the US.

It is also one of the most influential rates in the world, largely because it directly influences the world’s largest economy — the United States of America.

The US has a nominal gross domestic product (GDP) of US$22,7 trillion and accounts for 24,2% of the global economy. It is also the largest economy in trade, with US$1,6 billion (billion) worth of exports and US$2,4 billion in imports according to the CIA World Factbook.

Further, the US dollar accounts for 63% of official foreign currency reserves, and its sole use as a currency in global oil markets earned the currency its “petrodollar” status.

The high likelihood of sooner-than-expected rate hikes is likely to influence the exchange rate movements of other currencies. These movements can be explained by trade dynamics and capital flows.

The impact of trade can be unpacked by looking at a country’s current account, which focuses on the flows of real production, and the capital account which records financial flows. The current account tends to influence exchange rate movements through the flow supply/demand channel, among other channels.

The flow supply/demand channel is based on the supply and demand of currencies based on trade. A country that exports more than it imports typically experiences higher demand for its currency than is in supply, which subsequently drives the appreciation of net exporting country’s currency.

The reverse also holds true. A country that imports more than it exports typically sells more of its currency than is demanded, which exerts downward pressures on the currency.

The increase in the US Fed rate is likely to curtail the portion of expenditure that drives imports and the decline in imports will affect countries that export to the US because of less demand for the respective exporting countries’ currencies.

The increase in interest rates in the US also offers fixed income investors much better rates of return than other markets that opt to maintain low interest rates, under the assumption that the interest rate parity does not hold.

The expected increase in the Fed rate could trigger a disinvestment in countries with lower real interest rates in favour of fixed income investments in the US. We opine that Zimbabwe is not exempt from the impact of the possible rates hike by the Fed. The direct impact of the rate hike will be pronounced among businesses in need of US dollar capital to fund their projects.

The flow of funds out of emerging markets towards the US market could make it even more difficult for businesses to entice investors to invest in Zimbabwe without offering a higher interest rate that aptly compensates potential investors for the high country-specific risk in the southern African country.

As it stands, the African continent experienced capital outflows in excess of US$5 billion in the first quarter of 2021 alone, with South Africa’s outflows alone accounting for US$3,1 billion of that amount.

We also note a possible indirect impact emanating from the impact of the rate hike in South Africa. The US is South Africa’s third largest trade partner after China and Germany, and any decline in imports by the US is likely to prompt a depreciation of the rand in the short-term.

In addition, South Africa has less restrictive flows of capital and this could also lead to a further depreciation of the rand if the exodus of capital from South Africa is met by less-than-equal inflows of foreign capital. The short-term depreciation of the Rand could drive a marginal increase in imports from Zimbabwe, which largely uses the US dollar as a currency of choice alongside the Zimdollar.

The depreciation of the rand will also temporarily affect the level of South Africa’s imports from Zimbabwe because of the weaker rand against the stronger greenback. Given that South Africa is Zimbabwe’s largest trade partner, the possible indirect impact on Zimbabwe will be a negative trade balance in the interim.

The rand depreciated from ZAR13,77/US$ on June 15, 2021 to ZAR14,31/US$ on June 22 after the news of the possible hikes by the Fed.

Earlier this year, South African Reserve Bank governor Lesetja Kganyago hinted that key policy rates in the country would remain unchanged despite the capital outflows on the country and upward revisions in policy rates in other emerging economies.

However, with consensus estimates of the country’s latest inflation rate at 5,2% (just 80 basis points shy of the SARB’s upper inflation target of 6%), there could be pressure to revise the policy rate sooner than expected too.

Companies in Zimbabwe that extensively rely on South African imports could experience a short-lived reprieve on the back of a weaker Rand but taking advantage of this temporary window of opportunity will be limited by the efficiency of the FX interbank auction system.

Mtutu is a research analyst at Morgan & Co. He can be reached on +263 774 795 854 or tafara@morganzim.com

Recent Posts

Stories you will enjoy

Recommended reading