How the Fed's dovish interest rate stance affects UAE savers, borrowers and investors
Because of the dirham's peg to the dollar, the US central bank's new policy impacts those living in the Emirates
The Federal Reserve signalled last week it had finished raising interest rates - at least for a while - when it chose to keep them unchanged.
The change in stance was a sweeping pivot for the US central bank just weeks after the last quarter-point rate rise in December – the final of four increases in 2018 – when it lifted the federal funds rate target to a range of 2.25 per cent to 2.5 per cent. That was the ninth increase since 2015 when it started gradually increasing the cost of borrowing, with the Fed indicating there would be more to come to in 2019.
However, the Federal Open Market Committee said in a statement last week it “will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate”.
Sam Instone, director of financial advisory AES International says it is likely there won’t be any interest rate rises this year at all – especially in this quarter.
“The international situation is concerning and the Federal Reserve remains cautious,” he says. “Trade tensions, economic slowdowns in the EU and China and, of course, Brexit, are placing pressure on the global economy. Added to that is a burgeoning debt bubble – particularly on corporate levels – so it’s prudent of the Federal Reserve to act swiftly and pause any possible interest rate increases for the near future.”
US stocks rallied on the news of the Fed’s more dovish approach while Treasury yields fell and the dollar sank as investors digested the new message. The move also followed months of criticism from President Donald Trump for raising rates too much, who later tweeted: “Dow just broke 25,000. Tremendous news!”
But why is this significant for residents in the UAE? Tim Fox, chief economist at Emirates NBD, Dubai’s largest bank, says given the dirham currency peg to the US dollar, monetary policy is effectively set by the Fed in Washington.
“This means that interest rate changes in 2019 will depend on what the Fed does. At the end of last year markets were anticipating two to four US interest rate hikes this year, which could have meant interest rates being raised by as much as 1 per cent in the UAE in total.
“However, due to slowing global growth market expectations have reduced since then to the point where they are hardly discounting any rate increases at all in the US in 2019 and, by extension, in the UAE either.”
The Central Bank of the UAE raised its key rate by 25 basis points to 2.75 per cent on December 19, following the Fed's decision to hike the funds rate by 25 bps.
Avoid typical ‘lifestyle’ temptations during this time such as spontaneous luxury purchases, upscaling homes or cars.
Sam Instone, AES International
However, the situation could still change. Ambareen Musa, founder and chief executive of the financial comparison site Souqalmal.com says the Fed’s more cautious tone “doesn't mean there won't be any rate hikes in 2019”. “The Fed's policy stance is on the lines of a 'wait-and-see' approach, so there's no reason why bank customers should take any drastic decisions,” she adds.
Mr Fox says the US economy is still in relatively good shape, so “it probably still makes sense to factor in the possibility of one or two rate hikes over the year as a whole”.
“This may serve to restrain borrowing in the UAE, which would also be a further headwind to discretionary consumption and to overall growth,” he adds.
Mr Instone advises residents to exercise better financial habits – whether it’s paying off debt, saving more, spending less or seeking financial advice.
“Avoid typical ‘lifestyle’ temptations during this time such as spontaneous luxury purchases, upscaling homes or cars. These decisions could come back to haunt you if interest rates rise and loan repayments and credit card instalments become difficult to afford.”
Here's how a gentler interest rate policy from the US affects the finances of UAE residents:
Jonathan Rawling, chief financial officer of UAE financial comparison site yallacompare, says some economists are still predicting two interest rate increases in 2019 – down from an earlier outlook of three.
“Generally speaking this is good news for savers and bad news for borrowers," he adds.
Ms Musa says the current interest rate environment is “ideal for savers”.
“Now may be a good time to lock in a high interest rate on fixed deposits or park extra cash in high-interest savings accounts,” she says. “Local banks are already offering some very unique savings products that offer better-than-ever returns coupled with little to no restriction on withdrawals. It would be worth exploring such options, especially if you're looking for low-risk savings products.”
According to yallacompare’s Consumer Confidence Survey for the fourth quarter of 2018, 57 per cent of UAE residents say they are saving less than they were in 2017, while 48 per cent claim to have less credit card debt.
“This suggests to us that UAE consumers are taking a prudent approach and paying down debt rather than saving,” says Mr Rawling.
Lower interest rates mean cheaper debt, says Mr Instone, who advises anyone applying for loans and credit cards to “err on the side of caution” as the situation could change.
“Avoid the temptation of taking on more debt than you can afford. It’s also important to note that lower interest rates signal slower economic growth, meaning fewer job opportunities and salary increases. It’s particularly necessary for residents to save for a rainy day,” he adds.
Ms Musa says with no imminent tightening of monetary policy by the regulator, local banks may be more open to keeping credit card and loan rates as competitive as possible.
“This would essentially give prospective borrowers some breathing room, and allow both retail and business customers to access finance at reasonably lower borrowing costs in the future. The move also helps alleviate rising worry among potential borrowers who were seeing loans consistently become more expensive.”
For those looking to sign up for a mortgage, the advice is always to lock-in the lowest rate possible.
With no clarity on whether rates will stay stable, go up or go down, Ms Musa advises browsing the market carefully.
“Given this uncertainty, mortgage applicants can either choose to lock in the lowest possible fixed rate for the first few years or opt for a variable rate arrangement and negotiate lower bank margins for the entire tenure,” she says. “Borrowers should also factor in other costs such as processing fees and partial settlement fees that certainly impact the overall attractiveness of a home finance product.”
Gordon Robertson, director of financial advisory group InvestMe Financial Services in Dubai, says in the past the Federal Reserve was “more accommodative to stock markets than the economy itself”.
“When they do see any evidence of a crisis, then the Fed lowers the rates,” he adds. “Rightly or wrongly this pumping of money into the system has benefited the stock market.”
Mr Robertson says Fed chair Jerome Powell’s rate hiking schedule came after he found a mismatch between the economy and the excess free money available.
“Then came the worst year for the markets since the financial crisis so, at the last interest rate meeting, Mr Powell talked about global cross currents. He is turning US monetary policy into a global monetary policy," says Mr Robertson.
“As such we now have a dovish Fed; this should result in stronger stock markets, a weaker dollar and rates that are unlikely to rise until either inflation raises its ugly head or a recession brings a drop in rates.”
Despite the change in policy, Mr Instone, who advises investing in a globally diversified portfolio, says investors should not take any drastic action.
“Simply stay invested in low-cost index funds and focus on your long-term goals. Don’t mess with your investment as doing so can result in poorer performance,” he says. “It’s important for investors to remain unaffected by any economic or market shifts. Block out the ‘noise’, don’t speculate and exercise discipline. Your investment strategy should be working for you during both good and bad times.”
Mr Robertson says a potentially weaker dollar, means those sending money home for investments overseas will receive less for their dirhams.
“I suggest buying the currency forward, thus locking in your foreign exchange exposure," he adds. "There are many banks and foreign exchange platforms that can help. The latter tends to be cheaper but in both instances you will need a deposit which is typically 10 per cent of the amount you are hedging."
Updated: February 7, 2019 08:54 AM