On July 27, the Federal Open Market Committee (FOMC) announced the latest interest rate resolution, raising the benchmark interest rate by 75 basis points to a range of 2.25% to 2.50%, which was in line with market expectations. This has made the cumulative interest rate hikes from June to July to reach 150 basis points, the highest since Paul Volcker took over the Fed in the early 1980s.
The FOMC statement said that members unanimously voted 12-0 on the rate decision. Inflation in the U.S. remains stubbornly high, reflecting supply-demand imbalances related to the COVID-19 pandemic, rising food and energy prices, and broader price pressures. “We are highly attentive to the risks high inflation poses to both sides of our mandate, and we are strongly committed to returning inflation to our 2 percent objective”, the statement said. It also reiterated that the FOMC anticipates “that ongoing increases in the target range for the federal funds rate will be appropriate”, and that the Fed would adjust the policy if risks hinder the achievement of its inflation target. The Fed also warned that while U.S. job growth has been strong, recent indicators of spending and production have softened. The statement also stated that it will accelerate the unwinding of the balance sheet in September as planned, with the monthly shrinking limit for mortgage-backed securities (MBS) rising to USD 35 billion and the monthly shrinking limit for treasuries rising to USD 60 billion.
The U.S. raised interest rates by 75 basis points, still a strong rate hike. In the past two months, the Fed has raised interest rates by 150 basis points, the largest since the 1980s. However, U.S. stocks rose sharply after the announcement of the rate hike. The Dow rose 436.05 points (+1.37%), the Nasdaq 469.85 points (+4.06%), and the S&P 500 rose 102.56 points (+2.62%). Gold price also increased after Fed Chair Jerome Powell's remarks, as high as USD 1,739.6, or 1.2%. Cryptocurrencies surged sharply as well, with Bitcoin jumping 8.8% to USD 22,811 and ether up 16% to USD 1,594. The 10-year U.S. Treasury yield dropped to 2.72% at one point but rose to 2.82% after Powell said there was no recession in the United States.
Why did the U.S. capital market react so strongly after the Fed raised interest rates?
From the follow-up observation of the market, the following reasons can be discerned: (1) The rate hike this time was within market expectations. In the past, the market expected a rate hike of 75 or 100 basis points, but the Fed actually chose a lower rate hike. (2) Fed Chair Powell said that the U.S. economy is not in a recession at present, and it has not started to soften as previously expected by the market, especially since the employment growth is still strong. In the eyes of the market, if the Fed raises interest rates within a certain rhythm, it means that the U.S. economy is doing fine. (3) Against the background of the war in Ukraine, Europe has been affected, global inflation is rampant, and energy and food issues are still in crisis. Meanwhile, China’s economy is weak, and potential risks in emerging markets have increased. This leaves funds worldwide having no other option but to flock to the safest U.S. market that still has the potential to pay off. (4) The prospect of continued interest rate hikes in the U.S. has further boosted the dollar, and global funds have flocked to strong dollar assets. (5) The performance of U.S. technology companies had previously worried the market, yet the disclosure showed that it was better than expected, driving the Nasdaq to rise sharply.
The performance of the U.S. capital market will help strengthen the confidence of the Fed to adjust its monetary policy. What impact then, will the U.S.’ sharply raising interest rates have on other major global central banks, including that of China? Researchers at ANBOUND believe that the People’s Bank of China (PBoC) needs to be viewed separately from the central banks of other countries. This is because the PBoC and the Chinese economy are currently encountering different problems compared with other countries.
First of all, the world's major central banks will passively follow the Fed to raise interest rates. Because the central banks around the world had previously underestimated the severity of inflation, they now need to work harder to restore their credibility. Bloomberg economists expect global inflation to rise further to 9.3% in the third quarter from a year-on-year pace of 9% in the second quarter, before falling back to 8.5% by the end of the year. As a result, central banks in many advanced and emerging economies currently have no other alternative but to continue raising rates while inflation has not yet peaked. A prevailing view is that it is necessary to endure slower economic growth in order to restore global stability.
Secondly, the PBoC is in an awkward situation with its monetary policy. The current problems encountered by the Chinese economy are different from those in the world. In the first half of this year, the impact of the COVID-19 outbreaks and strict control measures have seriously disrupted the recovery process of the country’s economy and artificially created a sharp economic slowdown. This situation significantly curbs the possibility of China's central bank raising interest rates. While other central banks fret about inflation, China's biggest worry is how to pick up a slumped economy. Moreover, due to the accumulation of internal systemic risk factors in the Chinese economy, there are still a lot of uncertainties. Therefore, the Chinese market is concerned about whether the PBoC will cut interest rates to stimulate the economy. It should also be pointed out that for China, the Fed’s rate hike will bring pressure from two directions. On the one hand, the U.S. will raise interest rates ahead of the curve, compressing the room for China’s monetary policy to continue to be loose; on the other hand, the Japanese yen and the Southeast Asian currencies influenced by it, relative to the depreciation of the yuan, will also constitute competition for China's exports. This means that there is limited room for China to tighten or ease its policy.
Thirdly, China is not considering raising interest rates at the moment, which seems to match its current low inflation. Yet, such low inflation occurs after the economy was “frozen” by COVID-related measures. It is an imbalance in the statistical structure under policy intervention. If energy prices continue to rise in the future and some unexpected situations occur in the Chinese market, it is possible that the country’s inflation will also rise. This is something that China is highly concerned about; hence the Central Committee and the State Council have repeatedly emphasized the need to stabilize prices.
It has been pointed out by some that, in face of interest rate hikes by the Fed and major central banks around the world, the PBoC is relatively “calm”. For example, since July 4, the PBoC has carried out a small-scale reverse repurchase operation of RMB 3 billion for 10 consecutive trading days, triggering discussions in the industry about market liquidity and the direction of monetary policy. The market estimates that the central bank will continue to fine-tune monetary policy and maintain the monetary needs of the economy. However, rather than being “calm", it is more accurate to say that the economic situation does not allow China’s monetary policy to follow in the world’s footsteps.
Final analysis conclusion:
The Fed's strong interest rate hike has further strengthened the pattern of tightening monetary policy by the world's major central banks, and most of the world's central banks will have to follow the Fed's pace. However, the People’s Bank of China may be an exception. Under different economic pressures, the main task facing China’s central bank is to help stabilize its economy and maintain a relatively loose monetary environment without continuing to overdraft credit and future monetary policy space. However, it remains to be seen whether such a desperate monetary policy operation can be realized.
