Should Malaysians be worried about the U.S. raising interest rates? Let’s explain why that’s a Yes.
Halfway around the world, the Federal Reserve (Fed), U.S’s central bank, is getting ready to raise interest rates. This has many consequences for the various countries around the world, and could affect ordinary people.
What are the impact of a rising interest rates in the U.S. to ordinary Malaysians then? Read on to find out.
Contents
#1: Lower Investment Returns
This might sound unbelievable and far-fetched, but the interest rate is not just the rate that you see on your loan, credit card, or in your fixed deposits. Most importantly, interest rates are tied to government bonds prices, and not just in the U.S. but the whole world’s government bonds. When the Fed increases interest rates, it will lead to bond yields on U.S. government bonds to also increase. How does this work?
Let’s say a U.S. government bond promises to give you $100 in one year. In order for the U.S. government to incentivise people to buy their bond, they would have to sell the government bond at a lower price such as $95. The interest rate or bond yield would then be 5% ( (100 – 95)/ 100 = 5% ).
Now, if the Fed wants to reduce interest rates, it would buy the government bond at a higher price of $97 from you, which reduces the interest rate to 3%. On the other hand, if the Fed wants to increase interest rates, it will sell the government bond back to you at $94, increasing the interest rates to 6%.
If both U.S. and Malaysia government bond yields are the same initially at 3.5%, an increase in U.S. interest rates will cause U.S. government bond yields to increase to 4.0%. Investors who were initially invested in Malaysian government bonds will sell them, in favour of U.S. government bonds that have higher bond yields. Prices of Malaysian government bonds will then drop, reducing the returns for Malaysians who are still holding Malaysian government bonds.
This doesn’t just apply to government bonds. Investors who invested in Malaysian stocks will also sell them to move into U.S. government bonds that have higher returns. This will reduce the share prices of Malaysian stocks and generate lower returns for Malaysians.
#2: Weakening Ringgit and Higher Prices
That’s right. The ringgit will get weaker. If you buy a lot of imported items, they will become more expensive. This will also mean that the vacation that you want to take to the U.S. will get even more expensive with the weaker ringgit.
How does the ringgit get weaker then? When the Fed raises interest rate, investors will sell Malaysian government bonds and stocks to go to U.S. government bonds that have higher yield. In order for this to happen, they would have to buy more U.S. dollars with Malaysian Ringgit, which strengthens the dollar and weaken the ringgit. An exchange rate of RM4.20 per dollar, would increase to RM4.30 per dollar as people buy more U.S. dollars.
The last time the Fed hinted that it might increase interest rates in 2013 and 2014, the ringgit weakened from RM3.06 per dollar in December 2012 to RM3.35 per dollar in January 2014. The current RM4.20 per dollar might weaken further if the Fed decides to increase interest rates this year.
Prices of ordinary products might also increase if the company that produces them, needs to import raw materials from overseas. They would now be more expensive with the weakening ringgit, and companies might pass on the cost increase to you.
#3: Malaysian Economy Could Be Affected
As mentioned in point #1, a higher U.S. government bond yield would lead to more investors taking money out from Malaysia and putting them into the U.S. When this happens, the Malaysian central bank, Bank Negara, might be worried that the ringgit might be too volatile and could try to increase interest rates to attract the money back to Malaysia.
When the ringgit weakens, prices might be higher as shown in point #2, and Bank Negara might want to increase interest rates to prevent prices from increasing. In this context, the Malaysian economy might be negatively affected if interest rates are higher. Consumers might want to save more as returns are now higher in the bank (higher interest rates) and not spend as much. Businesses would want to invest less as loans are getting more expensive.
All of this leads to slower economic activity, with companies potentially making less money. Your job might be at risk if the company is not able to cope with this, and salary increases will be less likely also.
#4: Higher Loan Repayments
In point #3, a higher interest rate in the U.S. might prompt Bank Negara to also increase its interest rates. When that happens, your loans’ interest rates would also increase. If you have opted for a fixed interest rate loan, you don’t need to worry as you will still be paying the agreed interest rate in your contract.
However, fixed interest rate loan is becoming rarer these days, as more and more Malaysians opt for loans that are more flexible. If you have a flexi loan, the interest rate on your housing loan will be dependent on what is the base interest rate set by Bank Negara. When interest rates are low like now at 1.75% (Overnight Policy Rate), you will be enjoying low interest repayments. However, if the interest rate increases to 3.00%, you would be paying almost twice the interest rate on your loan.
While this might seem scary at first glance, default rates in Malaysia so far have been quite low and are also decreasing. The non-performing loans ratio to total loans decreased from its peak of 1.7% in August 2021 to 1.4% in December 2021. Even if interest rates increase, Malaysians will still be able to afford the interest rate repayments.
Conclusion
The Fed’s decision to raise interest rates has some big impacts on Malaysians halfway around the globe. Make sure you are well prepared to deal with them.
Worried about the Fed? Let us know your concerns in the comments below!
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