US Fed Reserve announcement: Why investors are anxious to know when interest rates will rise

The United States Federal Reserve has kept its main benchmark interest rate at rock bottom levels for more than six years.

On Thursday at 2am Singapore time the Federal Open Market Committee, the Fed's policy-making arm, is expected to offer clues on just when rates will rise after completing its regular two-day meeting.

Borrowing money in the world's largest economy has been ultra-cheap since the depths of the global financial crisis in December 2008, as the Fed worked to get the battered US economy moving again.

Bear in mind that the US recession brought on by vast numbers of mortgage defaults by borrowers who never had the money to repay their banks was the worst in US history since the Great Depression in the 1930s.

And that financial earthquake was felt across the globe.

As it tackled the crisis, the Fed used another weapon in the arsenal of central bankers: effectively printing vast sums of money, a policy known technically as "quantitative easing" where the central bank buys bonds issued by the government.

1. Why do they do this?

The idea is that between very cheap credit and lots of extra money washing around the system, the economy has a good chance of being kickstarted back into action.

Businesses and consumers will be more likely to borrow and spend money - and this creates more jobs and more economic activity.

And indeed, the US economy has improved a lot with unemployment down around 5.5 per cent from over 8 per cent and economic growth coming in at 2.4 per cent last year - with possibly even stronger growth set for this year.

Still, in a mixed picture, some economic data has been less than rosy, leading some analysts to wonder if the Fed needs to hold fire on rate rises.

So what now?

2. Timing is everything

Over recent months, the Fed has made it clear that interest rates will rise at some point. It has already brought an end to its massive money-printing programme.

The crucial question is: exactly when will the Fed raise its benchmark Federal Funds Rate, now at just 0.25 per cent?

Central bankers worry about acting too soon - in this case that raising rates too quickly - will snuff out the nascent US economic recovery.

But they also worry that acting too late could bring other problems - inflated asset prices for instance if ultra-cheap credit gets out of control.

That's where the word "patient" comes in.

In earlier statements the Fed has repeatedly said it will be "patient" in waiting for an economic recovery to take hold before raising rates.

Analysts believe that if the Fed drops this use of the word "patient" in its statement Thursday Singapore time that might well mean rates will rise as early as June.

3. How about the rising US dollar?

Lots of countries around the world are effectively trying to reduce the value of their currencies as a way to make their exports cheaper in foreign markets.

But the US dollar has been rising very strongly for months now, which of course makes US exports more expensive in foreign markets.

That's important because in recent times, a significant number of factories have moved back to the US after its manufacturing sector took a hammering as a result of cheaper centres such as China.

One factor the Fed will probably be weighing up is that higher interest rates will tend to cause the US dollar to move even higher.

4. Why would anyone in Singapore care about the Fed's decision?

Anyone with a mortgage or savings account in Singapore knows that interest rates have been rock bottom for some years here too.

But in recent months, rates have started to rise. In Singapore, it's not the central bank that sets intesest rates directly, but rather the banks.

Many home owners here have mortgages linked to a fluctuating interest rate. One of the most common is the Singapore Interbank Offered Rate (Sibor) - which is basically the rate at which banks lend money to each other.

So if the Sibor goes up, a borrower with a mortgage pegged to Sibor will face higher rates.

The complex interweaving of global currencies, interest rates and economic activity is hard to grasp - even for the experts.

But broadly speaking, if interest rates rise in the United States that might lead to higher borrowing costs for banks here - and therefore to higher mortgages for Singapore borrowers down the track.

5. The US Fed is going in the opposite direction of many central banks

Just as the Fed contemplates a rise in US interest rates, plenty of central banks around the globe are doing just the opposite - cutting rates and using the same kind of "quantitative easing" as the US used in recent years.

The European Central Bank has done both. The Reserve Bank of Australia, Bank Indonesia and the Reserve Bank of India are just a few of those to raise rates recently.

Analysts worry about this sort of imbalance - with the US apparently coming out of recovery, and looking to making borrowing costs higher, but with many other economies doing precisely the opposite.

gordon@sph.com.sg