In-depth analysis: The impact of the Fed raising interest rates

Highlights Aug.29,2022 07:42

Let's take a look at where rising U.S. interest rates may have impacted markets and the economy, with Fountain Hedge Ventures inferring that we're entering a new central banking system, and China's new quarantine rules will have some impact on economic growth.

One of the most successful moves to avert the collapse of the financial system when the coronavirus hit in March 2020 was the Federal Reserve's program to buy corporate debt. As it turns out, the announcement effect itself was so powerful that in the end the Fed didn't even have to buy much bonds - the market had already adjusted itself. The Fed may be doing something similar now, but this time fighting inflation. The Fed only raised its benchmark interest rate to 1.75%, which is still well below U.S. inflation, which is above 8%. But more action plans by Fed Chairman Jerome Powell and his colleagues are helping the Fed's moves play a bigger role. The current rate hike mainly caused the following changes in the market.

US dollar strengthens
The rate hike changed the dollar's inflation-adjusted index against a basket of currencies of U.S. trading partners. "The real trade-weighted dollar has a pretty big impact on the U.S.," JPMorgan chief economist Feroli said on Bloomberg TV Tuesday. He said it would hit "external performance" - a sign that the export growth in the latest trade data may not be sustainable. Feroli expects a slowdown in the broader factory sector. He also noted that the appreciation of the U.S. dollar has restrained the rise in the cost of imported goods. Import prices rose less than 1% month-on-month in April and May 2022, down from an average increase of more than 2% in the first three months of 2022.

Real estate prices pull back
Mortgage rates have soared far more than the Fed's policy rate. 30-year fixed-rate mortgages averaged 5.81% through June 2022, up about 2.7 percentage points since the end of December. By contrast, the Fed's rate rose by 1.5 percentage points. "We're seeing the mortgage rate effect already having a pretty significant impact on housing activity," Feroli said. Mark Zandi, chief economist at Moody's Analytics, recently predicted that the housing market will adjust from "coast to coast."

Wealth effect
The amplification effect of the Fed's policies has dealt a severe blow to household financial wealth. From the end of 2021 to the end of June 2022, the U.S. stock market has lost more than $11 trillion in value. Bonds also saw heavy losses. Year to date, the classic 60/40 portfolio -- 60% in stocks and 40% in bonds -- is down nearly 16% in the first six months of 2022. It was the biggest first-half loss since 1988, according to data compiled by Bloomberg. For those worried about the Fed being far behind the curve in the inflation war, it's worth keeping in mind these powerful additional levers at work. But Standard Chartered's Steve Englander has a caveat. He worries that markets could declare victory too soon, sparking an "asset market frenzy" that could prompt more forceful action from the Fed.

Economic scenario
Fountain Hedge Ventures research shows that China's reduction in the quarantine period for incoming travelers is boosting sentiment, but unless more drastic measures are taken, the change is likely to have a minimal impact on the world's second-largest economy. That's also the view of economists, who are now firm on their GDP growth forecasts after China halved the quarantine period to seven days and imposed an additional three days of home surveillance. Most of them said that while the revisions indicated that Beijing was taking a more practical approach to its Covid-19 policy, it was too early to predict that the strategy would soon end. The government's growth target of about 5.5 percent this year remains a major challenge, they added.