Implications of US interest rate rise on the Gulf region

The independence of the US Federal Reserve or Central Bank seems to be under threat from President Trump who is casting doubts about Fed Chairman Jerome Powell fitness as Chairman of the Fed and blaming him for hasty decisions to raise interest rates and derailing the US economic recovery and even complaining that the Fed had “gone loco – crazy”.

President Donald Trump said the Federal Reserve is moving too fast with interest-rate increases and dismissed concerns about inflation, extending his run of criticism that central bankers have largely disregarded as they push ahead with higher borrowing costs. Asked if he regrets nominating Powell to his Fed chairmanship, Trump was quoted as saying “Too early to tell, but maybe.”

But the Fed Chairman seemed unmoved and has said neither he nor other Fed officials are letting Trump’s frequent complaints affect them, with the Chairman pointedly adding that “my focus is essentially on controlling the uncontrollable. We control what do.”

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So far the Federal Reserve has stood its ground with implications far beyond the US economy but to those countries whose currencies are pegged to the US dollar, and hence, US interest rate movements. The latest communications by Federal Reserve officials are seen as further confirmation of a strong economy showing no signs of slowing and a still tightening labour market that should soon lead to faster wage growth.

In other words, this is an affirmation of the continued gradual pace in rate hikes mapped out by Fed Chairman Jerome Powell and in the wave of similar remarks by so many other Federal Open Market Committee in recent weeks, reflecting an unusually firm Committee consensus.

The drop in the US headline unemployment rate to 3.7 percent is impressive, and even if the job creation figure was only 134,000, the big upward revisions mean the October month’s job gains still translates into a very healthy 208,000 average a month over the first nine months of this year compared to last year’s 182k average – and that in an economy that is supposed to be running out of workers.

Good news

In good news for the president, wages grew at their fastest rate for close to a decade. The unemployment rate in the US has not remained below 4 percent for a sustained period since the Vietnam War. The US has now added jobs every month for 97 months in a row – the longest run of job gains on record.

Second, for the Powell-led Fed, higher wage growth in itself will not cause anxieties over inflation, and that helps to put into context Powell’s remarks that drew so much reaction in the markets.

Some do not think his remarks were meant as a hardening per se of a hawkish messaging on the Fed's already presumed base rate path. He was instead delivering pretty much the same message but speaking to a more lay audience; Powell in fact has made a point of not only speaking in plain English but also reaching to a wider public than the markets or any particular tweeters.

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A December hike is about as certain as possible under the current outlook, and while the risks going into next year look to be tilted to the upside that all but ensures 2019 is equally certain to see further rate hikes, we would caution the actual rate decisions, and thus the pace and ultimate number of hikes, will be taken on a meeting to meeting basis.

This goes against President Trump wishes and he made his intentions clear by stating bluntly “I like low interest rates,” but whether the Fed will grant him his wish is another matter with an institution that vigorously defends its independence.

This is not particular to the United States as the current faceoff between the Indian Central Bank and the Indian Government testifies to political pressure to rein in central bank independence to government economic policies and loosen credit policies with Indian national elections next year.

Economic expansion

And so the US face off also continues – with Fed Chairman Jerome Powell aiming to extend the second-longest US economic expansion on record by moving interest rates up just quickly enough to prevent overheating, but not so rapidly that the central bank chokes off growth.

It is a fine balancing act that has political ramifications for the US mid-term but more crucially the next Presidential elections. President Trump understands this and he was on the spot when he stated that the economy is enjoying “record-setting” numbers and “I don’t want to slow it down even a little bit, especially when we don’t have the problem of inflation.”

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Economic facts and data will show who is on firmer ground, but for Gulf businesses, the expected US interest rate hikes and resultant Gulf interest rate rises should be warning enough to prepare them to re- examine their existing loan portfolios and lock in longer term fixed lower rates if possible.

Some lower tier credit risk customers might not have the luxury to do so, but top tier clients and new customers can at least try as higher interest rates are coming as surely as night follows day. But it is not the private sector that can start to plan ahead but Gulf regulators too.

These should now request Gulf commercial banks carry out stress testing their current loan portfolios against the expected interest rate hikes to assess any incremental non-performing loan (NPL) loss contingencies from marginal credits and those most likely affected by higher borrowing costs.

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Dr. Mohamed Ramady is an energy economist and geo political expert on the GCC and former Professor at King Fahd University of Petroleum and Minerals, Dhahran , Saudi Arabia and co author of ‘OPEC in a Post-Shale world – where to next ?’. His latest book is on ‘Saudi Aramco 2030: Post IPO challenges’.