The Fed’s interest rate hike and its impact
According to news reports, on July 26-27, the Federal Reserve held a meeting of the Federal Open Market Committee (FOMC) monetary policy. The meeting showed the following information: 1. The FOMC voted to raise the federal funds rate by 75 basis point. The statement expects that sustained rate hikes may be appropriate. 2. The FOMC will continue to reduce its holdings of Treasuries, institutional bonds and MBS in accordance with The Fed’s Balance Sheet Size Reduction Plan. 3. The FOMC will be firmly committed to restoring inflation to its target level of 2%. For the rate meeting in September, Fed Chairman Jerome Powell said at a press conference that the meeting in September may still raise interest rates sharply again, but the magnitude of the rate hike depends on the economic and inflation data. Now it is still impossible to give a clear estimation of it. The Fed’s rate hike reflects higher interest rates in the U.S. market. When the Fed decides to enter a rate hike cycle, it usually dumps a large amount of Treasury bonds into the market to recover the dollar in the market. This will lead to a decrease in the number of dollars circulating in the market. From a monetary point of view, the Fed’s interest rate hike is to reduce the liquidity of the US dollar and make the dollar scarce, which also means make the dollar more valuable, and thus the purchasing power will rise and the dollar index will be strengthened.
Since the US dollar is universal currency and dominates the global financial and monetary system and trade settlement system, the Fed’s interest rate hikes will not only have a great impact on the US economy, but also have a significant impact on other economies around the world. From the perspective of the financial market in the United States, the decline in dollar liquidity will make the dollar more valuable and the dollar index will also rise. The process of selling U.S. Treasuries to recover dollars means that the number of U.S. Treasuries in the market will increase, whose price fall and yield will rise. The increase in the cost of raising dollars will also affect the liquidity of US stocks (usually it will lead to the decline of US stocks in the short term). However, the return of capital in overseas markets brought about by the US dollar interest rate hike will lead to a rebound in US stocks and a considerable number of domestic debt-risk asset bubbles will be resolved in such process. This repatriation of capital will contribute to the growth of the U.S. real economy, the expansion of production capacity and the weakening of inflation. From the perspective of economies in the rest of the world, the massive domestic capital outflows caused by the dollar hike will create a liquidity shortage. When the currency in a certain country depreciates to a certain extent, the competitiveness of this country’s export trade will be greatly affected. Moreover, the virtuous circle of economic trade in this country will be destroyed, and there is even likely to be a regional financial crisis.
By Tao Cheng
