How Does the Federal Reserve Impact Us, the Regular Person on the Street
Have you always wondered how the Federal Reserve decisions impact us all the way on the other side of the world?
You would have surely heard all about the Federal Reserve (FED) increasing or decreasing interest rates, keeping the economy going, and many other statements. However, how does it actually impact you as the ordinary person on the ground? And especially if you are halfway across the world. Should you care about what the Federal Reserve does?
In a nutshell, the FED increases or decreases the interest rate of the economy. This means that it affects loan interest rate, fixed deposit rate, and borrowing rates. When the economy is weak, the FED decreases the interest rates which reduces fixed deposit rates. If you invested in fixed deposits, you will take your money out as the returns have decreased and spend them to purchase things. If you are a company, loan interest rates are lower which means you can borrow more to invest in projects to increase your business revenue.
The FED’s decision affects the exchange rate of the ringgit, and thus your decisions to buy imported goods or go on vacation.
How does the FED’s decision affect the exchange rate of the ringgit then? Put simply, assume that both Malaysia and the US have their own interest rates. Malaysia’s interest rate is 2% and the US interest rate is the same also at 2%. Now, imagine them to be the returns if you invested in Malaysian and US government bonds that is you will get 2% returns if you invest in them. If the US for some reason decreases its interest rates, which reduces the investment returns of US government bonds also to 1.5%, you will look at both returns and invest in Malaysian government bonds that have a higher return of 2%.
When investors want to buy more Malaysian bonds, they have to buy more Malaysian ringgit. When more people buy the Malaysian ringgit, the ringgit becomes more valuable, and it becomes stronger. If the US decides to decrease interest rates, investors will flock to buy more Malaysian government bonds and also the Malaysian ringgit. Hence, If you want to exchange your ringgit for US dollar, you will get more US dollar now when the ringgit becomes stronger.
This makes it cheaper to travel to other countries and especially the US also for tourism. For some of the American imported goods also, there is a possibility that prices will decrease also to reflect the stronger Ringgit. If the US increases interest rates, the opposite will happen. Exchanging ringgit for US dollar will yield you less US dollar, and that vacation will cost more.
It also affects the value of local investments in the stock market through foreign investor interest.
Similar to what happens in the previous point, foreign investors who faced lower returns from the US government bonds and interest rates, would in turn shift their focus to investing in the Malaysian stock market. As foreign investors are driven by the thirst for higher returns, the lower returns in US push foreign investors into riskier markets such as the Malaysian stock market. If the US reduces the interest rate, typically stock markets around the world including Malaysia’s will increase and vice versa. This inevitably affects your investments’ value either up or down.
This has actually happened to the Malaysian markets in the early 2010s when the FED reduced interest rates initially and signaled that it might increase. The Malaysian stock market value actually increase also initially and decreased after that. So be wary about the impact of the FED’s decisions on your investment.