US interest rate rise puts wheels in motion for turbulence in trade, M&A and emerging markets

With the US interest rate hike dominating the headlines, it is worth taking stock of the how the move will likely affect the logistics sector.

Standard economic theory dictates that when US interest rates rise (all other things equal), the value of the dollar should increase or appreciate against other currencies. This is because a rise in the rate of interest in the US relative to overseas gives investors a higher return on US assets relative to their foreign-currency equivalents. As foreign investors exchange their own currencies for dollars to buy up US assets, just like in any other market, an increase in demand leads to an increase in price, or equivalently, the value of the US dollar increases or appreciates. While this already happened to some extent in expectation of the increase, there was also an immediate impact in the aftermath of the event, with the dollar strengthening further against various currencies.

Standard economic theory also asserts that as the dollar appreciates, US import demand will rise whereas export demand will fall. This is simply because the cost of US imports are immediately cheaper following the exchange rate movement whereas exports are more expensive. But as logistics providers in the business of handling or organising international freight movements will know, it is important to realise that such volume changes do not happen overnight. Import and export quantities and prices are often set into contracts, lasting for up to a year or more, and of course vary in length by industry and firm. Moreover contracts are also staggered in time, they are signed every day and month of the year, meaning that during any period, just a fraction of the contracts will expire and be renegotiated. Thus the adjustment to trade volumes caused by interest rate movements will be slow and gradual.

And indeed, rather than over-focusing on the 0.25% change, it is more important to understand the likely trajectory of US monetary policy over the next few years. The Fed’s medium-term projection for its key interest rate is for it to increase to 1.5% in 2016 and 2.5% in 2017, followed by a further incremental increase to 3.5% in 2018. With the US seemingly set down this course, trade volumes will continuously adjust over the next few years in response to rate movements.

Aside from international trade, another pertinent impact the rate rise could have on the logistics sector relates to M&A activity, which has been steaming along as of late. Higher rates will raise the cost of borrowing in the US, making it more expensive to finance acquisitions through debt. However following many years of cheap money, companies are now set with strong balance sheets that are flush with cash primed for acquisitions, mitigating any dampening effect on M&A that rate rises could bring. In terms of international transactions, the appreciating dollar will make US companies more expensive for foreign buyers, while US companies looking for foreign targets will see their targets cheapen even further.

Talking of foreign targets, it is also worth acknowledging the impact that the rate rise will have on emerging markets. Aside from the trade and M&A effects already discussed, higher US rates will make life more difficult for emerging markets through at least two main channels. Firstly, emerging markets laden with dollar-denominated debt will see the cost of servicing that debt rise due to the strengthening dollar. This applies both to governments and the private sector. In fact, the IMF warned in a report it published in September 2015 that as advanced economies start to raise interest rates, emerging markets should brace themselves for an increase in corporate failures. Secondly, emerging markets will be faced with the dilemma of whether to increase their own interest rates in response to the US’ move. The case for rests with trying to stave off capital flight and maintaining the value of their currency, with the downside being that such monetary tightening will slow economic growth – an especially bitter pill to swallow for those emerging markets whose economies are already fragile.

For a thorough analysis of the state of emerging markets and the logistics opportunities within, look out for the publication of the Agility Emerging Markets Logistics Index 2016 in January.