Fed’s Rate Hike Dragging Global Capital Markets into Turbulence

The European and American stock markets saw another huge plunge on April 22. The three major stock indices in the United States all fell substantially. That day, the Dow Jones Index dropped roughly 1,000 points, the greatest one-day drop since October 2020 by 2.8%. The Nasdaq Composite Index dropped 2.5%, shedding more than 2% for two consecutive trading days. The S&P 500 Index also slumped by 2.8%. Similarly, in Europe, the STOXX Europe 50 Index went down 2.2%, the UK’s FTSE 100 Index dropped by 1.4%, France’s CAC 40 Index was also down 2.0%, and Germany’s DAX 30 Index saw a 2.5% downfall. The U.S. dollar index rose to 101.12, and the world’s major currencies such as the euro, the pound sterling, and the yen, to various degrees, depreciated against the U.S. dollar. On the same day, U.S. bond yields continued to rise. The 10-year U.S. Treasury yield rose to 2.944%; the 5-year U.S. Treasury yield increased to 3.049%, and the 2-year U.S. Treasury yield was up by 2.7620%.

With global inflation on the increase, the war between Russia and Ukraine is still ongoing, and with the recent resurrection of the COVID-19 outbreak in China, European and American stock and bond markets have seen a rare global capital market plunge over the same period.

The data revealed that the MSCI World Index sank by 8.79% during the year, and the Bloomberg Global Bond Indices dropped by 9.96%. Globally, it was the first decline in at least 30 years, pointing to increased investment risk in the financial markets and a shift in market expectations.

The Federal Reserve has hinted at hiking interest rates due to several factors. This helps to explain the recent dramatic loss in European and American stock markets, as well as the significant gain in the U.S. Dollar, at least in the near term. On the same day, Fed Chair Jerome Powell stated that the Fed may raise interest rates to combat growing inflation in the United States. Markets expect the Fed to increase rates by a total of 200 basis points by September, based on Powell’s remarks. That could mean 50 basis points of rate hikes in May, June, July, and September, which might raise the upper end of the target range for the federal funds rate to 2.50%. The federal policy justification is primarily to move the policy attention to combating inflation, in the hopes of catching up with inflation faster, and compensating for the federal policy of the previous year.

Researchers at ANBOUND have long warned that the Fed’s quick rate hike will surely result in two outcomes: slowed U.S. economic growth and increased capital market volatility. While the latest jobs report for the U.S. economy is encouraging, the rate rise has had an impact on the property market. If inflation continues high for an extended period, it will harm domestic consumption in the United States, stifling the country’s economic recovery and possibly producing stagflation. The 2-year U.S. Treasury bond rate, which is more sensitive to the U.S. economy, is currently nearing the 10-year U.S. Treasury bond yield, signaling a likely economic downturn in the U.S.

The zero-interest-rate policy followed by long-term quantitative easing after 2008 and expansionary monetary policy during the pandemic in 2020 resulted in the outburst in the U.S. capital market. Soaring high asset prices could have adverse consequences for the U.S. economy. The S&P 500 is currently trading at around 22 times earnings, and overall values are higher than they were before the pandemic. From the historical trend of rate increases in 2018, the current pace of federal rate hikes is expected to trigger stock restructuring and asset revaluation. Presently, the U.S. economy is radically different from the 2018 sprint for high-tech companies.

Because inflation is too high this time, the pace of rate increases is projected to accelerate, affecting business performance and valuations even more. As a result, rapid rate hikes will lead to more turbulence in capital markets. The Nasdaq Composite fell 9% in the first 15 sessions of April, market data showed. Some markets saw this as the second-worst performance in history since the same period in April.

When the Fed accelerates the uptrend in interest rates, capital market risks might rise, even more, exacerbating market volatility and shocks. Not only would this harm the United States, but it will also harm global capital markets. This shock starts in the stock and bond markets, but it quickly extends to the currency and commodities markets as well. Amid expectations of a rate hike by the Fed, the U.S. dollar will continue to strengthen, which could bring further turbulence in global capital markets, impacting various currencies like the Chinese yuan, and affecting emerging markets.

With the ongoing Russia-Ukraine war, global industrial chain restructuring, and the COVID-19 pandemic, capital markets do not see an optimistic outlook for the global economy, nor do they see central banks having solutions for tackling inflation. This turmoil is expected to continue to have an impact on global capital markets for some time to come, rising and falling in lockstep with inflation trends.

Wei Hongxu
Wei Hongxu
A researcher at ANBOUND, graduated from the School of Mathematics at Peking University and has a PhD in economics from the University of Birmingham, UK