NEW YORK (TheStreet) -- After today's jobs report from the U.S. Bureau of Labor Statistics, where nonfarm payrolls only grew by 173,000, the lowest total in months, the Federal Reserve may be no more likely to raise interest rates this September than it was a few weeks ago when the markets were in a tailspin over worldwide economic worries.
But it could still happen.
On September 17, the Federal Open Market Committee (FOMC) will meet and decide whether or not to raise interest rates for the first time in nine years. Until the recent global sell-off, most experts believed the Fed would raise rates to 0.5%. However, considering the latest developments, consensus is that this is becoming more unlikely.
A rate hike in September would cause a roller-coaster ride throughout the markets. But what will actually happen in the economy, if interest rates do head north?
1. Individuals and businesses will face higher lending costs, which could affect company's top and bottom lines.
The interest rate, or more precisely, the "federal funds rate," is the cost at which banks borrow money from the Federal Reserve banks. If the Fed raises the federal funds rate, borrowing money will become expensive for banks. That will effect individuals and businesses.
If banks face higher expenses, they will pass on these costs to their customers. Hence, individuals and companies will have to pay more for their credit card and mortgage interest rates and loans become more expensive. As a result, consumers could be spending less money.
Moreover, companies will borrow less and therefore could lack money they need for investments. That could have negative effects on companies' growth, profitability and so on.
2. Stock market may decline (although that rarely happened during previous tightening cycles).
Here's how it works: To determine a stock price, future cash flows are discounted and the result is divided by the number of shares. If companies face higher lending costs and less consumer spending, their cash flows could decline which would result in a lower valuations.
Higher interest rates make stocks less attractive compared to bonds. However, bonds released previously to the rate hike will become less attractive than newly issued bonds, unless, of course, they carry a floating interest rate. Net result will be bond prices declining.
There could be negative effects on stocks and bonds, markets have performed well during previous tightening cycles. Stock markets went up and bond declines were not very dramatic. The Fed will raise interest rates gradually, and it will only do that, Fed directors have said, if the economy is doing well.
3. Dollar will keep rallying and more money will flow into the U.S.
If the Fed decides to raise rates while other central banks are increasing their money supply, the dollar will keep rallying. That will increase American demand in Asia and Europe. More money will flow into the U.S. and most of it will go directly into equities. A stronger dollar will also have a positive effect on foreign government debt. However, this effect will be more than offset by higher borrowing costs. If interest rates increase gradually, the U.S. government could face additional financing costs of almost $3 trillion during the next 10 years.
An interest rate hike will impact the global economy. However, these factors are interrelated and, in the end, the overall effect will most likely be much smaller than many people assume.
The Fed has been preparing the market and therefore factors have been adjusted accordingly.
We'll know more on September 17, so stay tuned.
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- What the Fed is watching in the economy before it makes a decision.
- Why the Fed should be raising rates now.
- What happens when the Fed raises interest rates.