What Will Happen When the Fed Raises Rates?

03/20/2015 12:01 am EST

Focus: GLOBAL

Jim Jubak

Founder and Editor, JubakPicks.com

Looking at what's happened recently to some of the emerging market currencies has MoneyShow's Jim Jubak speculating on what may happen once US rates do move higher.

For the week ahead, I think since this is Fed week time, Fed speculation time, it's good to think about Christine Lagarde's warning about what happens when the Fed starts to raise interest rates.

Lagarde is head of the IMF, the International Monetary Fund, and what she's basically pointing out is that once the Fed starts to raise rates and we're probably looking at more than just a single rate increase. We're not going to go from zero to 0.25% and stop there.

Speculation is that we'll end at 1.5% maybe in 2015, then move up to 2%, 2.5%. A neutral rate would be something like 3% so looking at all of that and looking at what's happening with currencies, especially emerging market currencies, what Lagarde said basically was watch out, there's a big possibility for global instability once the Fed starts to raise rates, and you can see that in what's going on right now in countries like Brazil where you basically had currencies hammered on specific problems in the case of falling commodity prices, falling iron ore prices, turmoil in the Brazilian oil sector, because of scandal at Petrobras.

All that hammered Brazil anyway but then you've also got the problem that because the dollar is so strong, what you're seeing is money flowing out of these countries. You're seeing the currencies weaken and a lot of hot money that was invested there without any real sense of wanting to stay there but going there because the returns looked like they'd be good is moving out so that's investment money, as well as globally you've had a lot of corporations build up huge debt during the last five years and a lot of it in emerging markets was denominated in dollars, so if the dollar goes up against your local currency, now you've got to find a way to bridge that change and it makes the loan much more expensive than it was when you signed it.

What Lagarde is saying is watch out, once the Fed starts to raise rate on the dollar, if the dollar goes up even more than it has, which is a likelihood if the Fed gets launched on a pattern that suggests 2% rates at some point when you're still looking at most of these countries cutting their rates. Once that happens, then she says we really need to be very, very careful. Cash is going to slosh around this global economy in unpredictable ways and so what you should do is not just think about what the Fed is going to do once it starts raising rates and when that rate increase is going to be but what the pattern is after that because that's really where the next thing to start thinking about, the next danger to start thinking about in this market.

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