Hurry up, the boots have landed! The Fed's tightening cycle or restarting the global market may face a chain shock

The Zhitong Finance App learned that the Federal Reserve is tightening monetary policy, and the impact is likely to go far beyond the mainland of the United States. The Federal Reserve announced on Wednesday that it would raise the federal funds rate target range by 25 basis points to 3.75% — 4%. This is the first time that the Federal Reserve has raised interest rates since July 2023. What is more noteworthy is that the latest bitmap looking at the Federal Reserve's future policy operations shows that 16 of the 18 officials who submitted interest rate forecasts expect to raise interest rates at least once more during the year.

Federal Reserve Chairman Walsh said that the US economy is showing signs of strengthening, but the potential trend of inflation has not improved significantly. The current policy focus is to push inflation back down. Regarding this rate hike, Walsh described it as “reducing some policy easing.” He said that the current overall financial conditions are still difficult to call restrictive, and Federal Open Market Committee (FOMC) members generally agree with this judgment.

Historically, after the Federal Reserve began to raise interest rates, it often did not adjust it only once. When and how much will market attention be added before the announcement of this interest rate meeting? Now that interest rate hikes have come to fruition, the market is worried about whether this is the beginning of a new cycle of interest rate hikes, and when will the next one arrive? Traders currently expect the Federal Reserve to raise interest rates three more times by the middle of next year, one more than expected before the decision was announced. Interest rate swaps show that the next rate hike may come as early as next month.

This week's 25 basis point rate hike may not be an isolated policy adjustment. The next data on inflation, employment, and energy prices will be a key factor in deciding whether the Federal Reserve will continue to tighten its policy later this year.

Some experts said that for the global market, the new US austerity cycle may mean that the US dollar will strengthen, other regional currencies will face greater pressure, and at the same time, there will also be less room for other central banks to relax their monetary policies. Higher US interest rates may also keep global bond yields high and put pressure on stock valuations and economic growth.

The dollar is facing upward pressure, and other currencies are under pressure

One of the most direct channels for transmission of the Federal Reserve's tightening policy to the world is the dollar. Higher US interest rates will support the dollar while putting pressure on other currencies.

Mark Zandi, chief economist at Moody's Analytics, said that the Federal Reserve's interest rate hike and signals about another rate hike are putting some upward pressure on the US dollar, while putting downward pressure on other currencies, especially in economies where monetary or monetary policy is closely linked to US interest rates. Navin Saigal, BlackRock's Asia Pacific global fixed income director, also said that the market's hawkish interpretation of the Federal Reserve meeting “may put some pressure on the Asian currency and bond markets in the short term.”

Japan is one of the focus of the market's attention. Mark Zandi further explained that the weakening yen may further strengthen the Bank of Japan's reasons for continuing to tighten its policy. “This will indeed put pressure on Japan to continue to follow suit and raise interest rates.”

Currency depreciation may also make it more complicated for central banks to fight inflation, as weakening currencies will drive up the cost of imported goods denominated in local currency. This situation comes at a time when oil prices have risen sharply due to the conflict in the Middle East, putting some economies at risk of rising energy costs, weakening currencies, and high interest rates.

Other central banks' monetary policies may be affected

At a time when the Federal Reserve's policy is shifting, central banks in some major developed markets are also tightening their policies. The ECB raised interest rates by 25 basis points last week, while J.P. Morgan Asset Management expects the Bank of Japan to raise interest rates by 25 basis points this week. Tai Hui, Asia Pacific chief market strategist at J.P. Morgan Asset Management, said, “Central banks in developed markets are simultaneously tightening monetary policies to address inflation concerns.” The rise in US Treasury yields due to higher interest rates has also increased the possibility of capital flowing from other markets to the US, putting pressure on other central banks to respond.

However, the Federal Reserve's action does not necessarily mean that the world will simultaneously enter a cycle of interest rate hikes. There is an unusually clear divergence in the inflation situation among Asian economies. China and Thailand are still facing deflationary pressure, while inflation rates in Australia and Japan are still above central bank targets. BlackRock said that at the same time, India's inflation rate is roughly near the middle of the Reserve Bank of India's target range. This means that even if a stronger dollar reduces the room for policy makers to relax monetary policy, the domestic economic conditions of each economy may eventually overwhelm the pressure to mechanically follow the Federal Reserve.

High interest rates risk suppressing the stock market and economic growth

For financial markets, long-term high interest rates also mean that stocks and other risky assets face a higher threshold. Higher yields on government bonds will make fixed income assets more competitive than stocks, drive up corporate financing costs, and reduce investors' current valuation of future profits.

Liz Ann Sonders, chief investment strategist at Carson Wealth Management, said that the level of yield may not be as important as the rate at which yield rises and whether the process is orderly. She said that the 10-year US Treasury yield is generally reasonable, judging from factors such as inflation, Federal Reserve policy expectations, and strong nominal economic growth.

Liz Ann Saunders said, “I think if yield trends start to get out of order, then the stock market will face greater digestive pressure. But I believe that as long as this process is kept in order, the economy and the market will be able to withstand this kind of change to a certain extent.”

This pressure is also unlikely to be evenly distributed. Liz Ann Saunders said that higher interest rates have begun to impact areas of the market that are more sensitive to the economic cycle, and strong profits may further complicate the inflation outlook by supporting employment and recruitment.

J.P. Morgan's Tai Hui said that if the hawkish stance of the Federal Reserve continues until 2027, investors may need to re-evaluate valuations, especially for technology stocks that are relatively sensitive to interest rates.

For the global market, higher US interest rates are just one aspect. A strong US economy provides space for the Federal Reserve to tighten its policies, and may also support export demand and corporate activity in other regions. BlackRock's Navin Saigal said that the higher convenience ratio will put pressure on in the short term, and America's strong economic growth should continue to drive global economic activity, trade flows, and corporate fundamentals in the Asian region.