The US Federal Reserve (the US central bank) cut the deposit and lending interest rates by 0.5% to a range of 4.75% and 5%, which caused a wave of rises and falls in precious metals, commodities and currencies globally.
In this report, Al Jazeera Net simply explains – quoting experts and analysts – the meaning of the reduction decision and how it affects individuals around the world, especially in the Arab world.
Before asking questions and answering them, we must remember the following:
- Interest is the rate paid by the central bank of a country to commercial banks that deposit money with it, and this rate is what determines what the commercial bank will get when it lends to customers (individuals or companies).
- Interest rates are the main tool of central banks to control price levels in the country (inflation). Raising interest rates prompts people to deposit their money to benefit from higher rates of return, which in turn reduces liquidity in the markets and the demand for goods and services decreases, causing their prices to fall, which is what central banks have been targeting recently.
- Economic growth in any country depends primarily on the activity of companies, which in turn finance their activities in several ways, the most important of which is borrowing. Therefore, raising interest on lending raises the prices of goods and services for companies at a time when liquidity in the markets is declining and demand is decreasing, so companies refrain from borrowing at all and their businesses do not grow and may resort to laying off employees to reduce operating costs and maintain the growth of their businesses.
1- Why did the US Federal Reserve lower interest rates?
For two and a half years, the US Federal Reserve has sought to reduce price levels that rose after the outbreak of the Russian-Ukrainian war (Russia and Ukraine are global suppliers of many of the world’s basic commodities) at a time when the world was recovering from the effects of the “Covid-19” pandemic, which was an incentive to increase demand for goods and services.
The US consumer price index fell in August to 2.5% on an annual basis from 2.9% recorded in July, but the index is still above the US central bank’s long-term target of 2%.
Calls for a rate cut have increased following pressure from markets after data from the US labour market released last month led to expectations of an economic recession, causing a global wave of declines in stock markets led by US stock exchanges.
Rising unemployment coupled with a slowing labor market means slower activity among listed companies among the total companies.
The US Labor Department said in early August that nonfarm payrolls increased by 114,000 jobs in July, a number that was well below the median forecast of 175,000 jobs, and also far below the 200,000 jobs that economists believed were needed to keep up with population growth.
The unemployment rate jumped to 4.3% in July, near a three-year high.
Federal Reserve Chairman Jerome Powell said the bank might have started cutting interest rates in late July if it had known the labor market was slowing as quickly as it was.
2- How will the metals and commodities markets around the world be affected by the interest rate cut?
With the rise in US interest rates, investors and savers are seeking to invest in US Treasury bonds (fixed income instruments that lend the state a sum of money, and the holder is entitled to receive the interest due according to the interest determined by the Central Bank and the government) in order to benefit from the higher rates.
The flow of investors’ and savers’ money into bonds and treasury bills negatively affects the gold markets, which do not generate returns or interest, as well as precious metals.
Stocks also lose the opportunity to attract a portion of investors who prefer lower-risk fixed-income instruments (assuming that governments will not default on their debt).
The inflow of money into dollar-denominated investment instruments (including US Treasury bills and bonds) raises the price of the greenback.
But as interest rates fall, investment in these instruments declines and demand for other investment instruments increases.
Thus, yesterday, Wednesday, spot gold prices rose to their highest level ever, reaching $2,599 per ounce.
The prices of commodities priced in dollars – including oil – also rise after the US interest rate is lowered to increase demand for them, as one dollar will be useful in purchasing more of these commodities compared to what it was before when it rose.
This means that the prices of fuel and petroleum products will have gained an additional reason to rise globally.
3- What about the world and Arab region currencies after the interest rate cut?
Basically, the value of currencies is determined by the economic strength of the country, which is determined by its exports of goods and services to the world. The country that exports more and obtains (hard) currencies from other countries of the world has a strong currency, or at least has the opportunity to strengthen its currency unless it chooses otherwise of its own free will (the Chinese yuan, for example, is kept by China at a value lower than its actual value in order to increase its exports).
Since the dollar is the global trade currency and the dominant currency in global currency reserves, its decline is good news for other countries, especially Arab countries.
But 6 countries in the Arab world fix their currencies against the dollar at certain values and do not change them (Saudi Arabia, Jordan, the Emirates, Qatar, Bahrain, the Sultanate of Oman), and these countries will not be affected by either lowering or raising the US interest rate.
Among the countries in the region are those that attract hot money (investors seeking to benefit from higher interest rates compared to rates in their countries), including Turkey and Egypt, for example, and these countries benefit from the reduction in US interest rates by attracting more money.
4- How do savers and borrowers benefit from the US interest rate cut?
Experts always advise diversifying investment portfolios between stocks, real estate, gold and other instruments, in order to hedge against sudden fluctuations and benefit from various economic factors.
But there are cases where experts prefer to increase the holding of a particular asset, and in the event of a reduction in US interest rates, it is widely expected that the prices of gold, precious metals and stocks will rise, as more money is withdrawn from investment and directed towards these investment instruments, increasing demand for them and raising their prices.
In the event of a US interest rate hike, it is recommended to reduce holdings of precious metals and stocks and focus on investing in the dollar. In all cases, it is recommended to resort to a financial investment advisor to obtain professional guidance in this regard.
For commercial bank borrowers, if the Fed takes the same step, they will benefit from the interest rate cut, as they will be able to refinance their loans at a lower interest rate.
Commercial banks provide this feature in countries around the world and the Arab region. As for those who obtain new loans from commercial banks, they will naturally pay less interest than before.
