The Federal Reserve's Interest Rate Hike Cycle: A Multidimensional Analysis of Its Impact on Global and Encryption Financial Markets

Tracking the Federal Reserve's Rate Hike Progress

From March 2022 to 2023, the United States has completed a rare cycle of rapid interest rate hikes, with a total increase of 20 basis points (500 basis points), raising the benchmark interest rate from the range of 0 to 0.25% to the range of 5.00% to 5.25%.

The peculiarity of this interest rate hike cycle lies in its speed and intensity:

• All ten consecutive interest rate meetings resulted in rate hikes.
• In June, July, September, and November 2022, there were unprecedented consecutive interest rate hikes of 75 basis points four times.
• The rate of interest rate hikes is significantly faster than the past three rounds of rate hike cycles.

The main driving force behind the Federal Reserve's aggressive rate hikes this round is to control inflation. In June 2022, U.S. inflation indicators reached their highest level in 40 years, forcing the central bank to take strong policy action.

The Multiple Impacts on Global Financial Markets

Market reaction: US dollar strengthens

Rising interest rates usually drive currency appreciation, and this economic rule has been clearly reflected in the current rate hike cycle. In 2022, the U.S. dollar index rose by 8.5%, due to:

• The increase in U.S. interest rates has enhanced the attractiveness of dollar assets.
• Foreign investors are increasing their holdings of US dollars to obtain higher returns.
• Compared to other economies, the monetary policy of the United States is more aggressive.

Stock Market Dynamics: Stage Performance

Traditional financial theory holds that interest rate hikes are unfavorable for the stock market, primarily through two mechanisms:

• Valuation Compression: In asset pricing models, interest rates are inversely related to valuations.
• Profit Pressure: Rising corporate financing costs squeeze profits.

The performance of the major stock indices in 2022 confirmed this:

• The S&P 500 index fell by 17%
• The Nasdaq index fell by 30%

However, the stock market began to rebound in 2023, reflecting market expectations that the interest rate hike cycle is nearing its end. According to historical data, stock markets tend to strengthen during the late stages of interest rate hikes, highlighting the importance of market expectations regarding monetary policy.

Precious Metals Market: Gold Prices Turn

Gold and interest rate expectations exhibit an inverse relationship, specifically manifested as:

• Before November 2022: Expectations for interest rate hikes increased, putting pressure on gold prices and causing them to decline.
• From the end of 2022 to present: Market expectations for the interest rate hike cycle are nearing the end, and gold prices continue to rise.

This dynamic illustrates the sensitivity of the precious metals market to changes in monetary policy, as well as the key role that market expectations play in asset pricing.

Bond market volatility: Changes in liquidity and risk premiums

Interest rate hikes lead to higher rates, causing bond prices to generally decline, which in turn triggers a series of chain reactions:

• The value of the bond investment portfolio held by the bank has significantly shrunk.
• Some financial institutions are forced to sell bonds under market pressure to obtain liquidity.
• One of the important factors causing the recent crisis in the American banking industry.

The Chain Effects of the Federal Reserve's Policy on Taiwan's Economy

New Taiwan Dollar exchange rate pressure

The strengthening of the US dollar has led to the depreciation of the New Taiwan Dollar, and this currency dynamic further triggers multiple economic effects:

Inflationary pressure increases:

• The CPI for food in Taiwan rose by 6% in 2022.
• Egg prices skyrocketed by 26%, mainly affected by rising costs of imported feed.
• The United States, as Taiwan's largest agricultural product supplier (accounting for 22.8%), has seen a direct increase in import costs due to the appreciation of the US dollar.

Limited Policy Response:

• The Central Bank of Taiwan has raised interest rates five times, totaling 75 basis points.
• Compared to the Federal Reserve's 500 basis points increase, it still seems insufficient.
• Causing the New Taiwan Dollar to continue to be under pressure, increasing the risk of capital outflow.

Taiwan stock market and capital flow

The Federal Reserve's policies affect the Taiwan stock market through various channels:

• Capital Flow: In 2022, Taiwan's stock market experienced a capital outflow of 41.6 billion USD, the highest in the Asian market.
• Valuation Pressure: Rising interest rates lower stock valuation levels
• Market Performance: The Taiwan Weighted Index fell by 21% in 2022, ranking 6th worst globally.

However, certain sectors benefit from the tightening policy:

• Financial stocks (such as banks) benefit from the widening of the interest rate spread.
• Taking Taiwan Enterprise Bank (2834) as an example, interest income in 2022 grew by 38% to NT$33.3 billion.
• The stock price has increased by about 20% in the past year.

Unique Reaction Patterns of the Crypto Market

The cryptocurrency market shows a high correlation with the traditional financial market during the Federal Reserve's interest rate hike cycle, but also exhibits unique response patterns:

Liquidity Sensitivity:

• Major cryptocurrencies such as Bitcoin are highly sensitive to changes in global liquidity.
• Interest rate hikes have generally put pressure on risk assets, particularly evident in the cryptocurrency market.
• The price of Bitcoin fell more than 70% from its peak in 2022.

Changes in Correlation with Traditional Assets:

• Early stage of interest rate hikes: The correlation between cryptocurrencies and tech stocks strengthens, both affected by liquidity contraction.
• Mid to late interest rate hike: Some cryptocurrencies begin to show independent trends, reflecting the market's demand for alternative assets.

Unique Valuation Logic of Cryptocurrencies:

• Interest rate changes affect the risk-free rate of return, thereby altering the risk premium assessment of crypto assets.
• The capital participation of market institutions is affected by monetary policy, and the adjustment of institutional holding strategies impacts market structure.

Investment Strategy Adjustment Framework

In the face of the Federal Reserve's interest rate hike cycle, investors may consider the following multidimensional asset allocation strategies:

Core Configuration Strategy

Dollar Asset Allocation:

• Increase USD assets through various channels such as bank currency exchange, currency ETFs, etc.
• Consider USD time deposits for higher yields.
• Configure USD-denominated assets on global platforms to reduce currency depreciation risk

Stock Portfolio Adjustment:

• Reduce exposure to overvalued growth stocks (such as technology stocks)
• Increase allocation to high-yield stocks (such as financial stocks)
• Dynamically adjust industry rotation strategies based on the interest rate hike cycle phase.

Risk Hedging Mechanism:

• Reduce portfolio volatility through index hedging instruments
• Utilize the high correlation between the Taiwan Weighted Index and the Nasdaq 100 Index for cross-hedging.
• Gradually reduce hedging positions during peak market panic.

Cryptocurrency Asset Allocation Ideas

Periodic Allocation Strategy:

• Early stage of interest rate hike: Maintain a lower position and prioritize allocation to mainstream cryptocurrencies with liquidity advantages.
• Interest rate hike medium term: Gradually increase the allocation of quality crypto assets, focusing on projects with solid fundamentals.
• End of interest rate hike: Consider increasing risk exposure and positioning in segments with growth potential.

Liquidity Management:

• Ensure that the investment portfolio has enough cash buffer to cope with market fluctuations.
• Maintain a reasonable amount of funds on mainstream trading platforms to seize opportunities brought by market fluctuations.
• Set strict stop-loss strategies to control the risk of a single position.

Asset Diversification:

• Use cryptocurrencies as part of the overall investment portfolio to complement traditional assets.
• Set a reasonable allocation ratio for crypto assets based on individual risk tolerance.
• Regularly rebalance the investment portfolio to maintain the target risk level.

By thoroughly understanding the impact mechanism of the Federal Reserve's interest rate hikes on diverse financial markets, investors can develop more refined investment strategies to seize opportunities and manage risks amid market volatility. It is important to recognize that each round of interest rate hike cycles has its unique characteristics, to pay attention to policy shift signals, and to timely adjust investment decisions in response to changing market conditions.