This morning, Fairfax media reported this curious sentence:
"US stocks ended up slightly on Wednesday, with the S&P 500 hitting a record high close, after minutes of the Federal Reserve's latest meeting showed policymakers view a rate hike coming soon."
That was a surprising, because none other than Warren Buffett, one of the world's most successful investors, has repeatedly stated that stocks typically move in the opposite direction to interest rates over the long term.
That is, as rates go up, stock prices typically go down because the alternatives to stocks (bonds and savings accounts) are more attractive. Interest expenses also rise and consumers have less money in their pockets, which leads to lower company sales.
At the moment, it is early days for the USA's rate rising scheme. However, rate increases could have a surprising knock-on effect to the Australian economy and stock market, for several reasons:
Australian banks
The USA is a significant source of wholesale funding for our big banks like Commonwealth Bank of Australia (ASX: CBA) and Westpac Banking Corp (ASX: WBC). As US rates rise, the rate that our banks borrow at also increases. This could squeeze margins, or lead to increased competition for domestic deposits, which would also squeeze margins, unless our banks lift rates.
With Australian banks effectively driving the S&P/ASX200 (INDEXASX: ^AXJO) (ASX: XJO) much of the time, US rate rises could have an impact on our own stock market.
A higher US Dollar
Higher US interest rates would typically see the US Dollar strengthen further against the Aussie Dollar. It could also lead to money flowing out of Australia and into the USA, taking some of the buoyancy out of our share market, which is attractive for its big dividends.
US-based companies
Finally, there are a number of Australian companies including Westfield Corp Ltd (ASX: WFD), Brambles Limited (ASX: BXB), Boral Limited (ASX: BLD) that either have significant operations in the USA and/or large chunks of debt denominated in US Dollars. Particularly for the consumer- and construction- activity centred stocks like Westfield and Boral, rising interest rates brings all sorts of challenges and opportunities.
That's not to say that investors should run for the hills. Putting aside a little extra cash for investment purposes could pay off if the market declines to silly levels.
