New York, December 14, 2016 — The US Federal Reserve’s 25-basis-point increase in the federal funds rate today reflects a strengthening US economy that should continue to expand through 2018, says Moody’s Investors Service in a report. While the impact of the rate increase on the US economy will be negligible, emerging market economies with large external funding needs and macroeconomic imbalances could be vulnerable to capital outflows.
Moody’s expects the Fed to tighten at a very gradual pace, with two to three more rate increases pushing the fed funds rate to around 1.25% to 1.5% by the end of 2017.
“In the near term, the rate increase will have only a negligible impact on the government’s borrowing costs,” said Sarah Carlson, a Senior Vice President at Moody’s. “However, due to the relatively short average maturity of outstanding US Treasuries, the US’s interest burden will rise relatively rapidly, as the fed funds rate increases and if inflation expectations rise further.”
Moody’s expects the government’s net interest expense to rise to 12.7% of total spending in fiscal 2025—a level last seen in the early 1990s—from 6.6% in fiscal 2016, in line with Congressional Budget Office forecasts.
The impact of a higher fed funds rate will likely be more noticeable in some emerging market economies than in the US, said Madhavi Bokil, a Vice President and Senior Analyst at Moody’s in New York.
While emerging market economies could benefit from a strengthening US growth if it stimulates demand for exports, they could also suffer if higher US rates lead to a more sustained re-pricing of financial assets and tighter global financial conditions. The most direct impact will felt in those economies that have high external financing needs relative to their foreign exchange earnings and reserves.
The spillover effect may manifest itself in different ways. For instance, in some cases, a pronounced currency depreciation could lead to higher inflation, which, along with the threat of sustained capital outflows, could force central banks to raise interest rates.
Moody’s subscribers can access the report “Interest Rates — US Rate Hike Reflects Economic Growth; US Borrowing Costs to Rise in the Long Term,” at