How does the interest rate hike cycle change asset performance? Analyzing when the US raises interest rates and market mechanisms

The Origins and Development of a Rapid Rate Hike

The wave of rate hikes starting in 2022 is considered one of the most aggressive monetary policy adjustments in history. In just 21 months, the Federal Reserve raised the benchmark interest rate from near zero to over 5%, totaling a cumulative increase of 500 basis points. Even more remarkably, during 10 consecutive FOMC meetings, the Fed consistently raised rates, with four consecutive increases of 75 basis points in the summer and fall of 2022, which is rare in recent decades.

This aggressive policy was driven by an inflation crisis. By mid-2022, US inflation reached a 40-year high, forcing the Fed to take extreme measures to curb inflation expectations from spiraling out of control. However, rate hikes also introduced new risks—part of the banking crisis in 2023 stemmed from sharp declines in long-term bond prices amid rapid rate increases.

When Will the Rate Hike Stop? How the Market Prices the Future

Regarding when the US will truly stop raising rates, the market has formed a relatively consensus expectation. According to data from the CME Fed Funds Futures market, the Fed is expected to gradually cut rates in 2024, with rates decreasing month by month from the early-year range of 5.25-5.50%, ultimately falling back to around 4% by year-end.

This outlook is based on two key factors: first, inflation has eased but remains above the 2% target, requiring cautious policy adjustments; second, the fragility of the banking system has become a new constraint—excessive tightening could trigger financial stability risks. Therefore, the end of the rate hike cycle is clearly in sight, but the timing of rate cuts remains to be closely watched by the market.

How Rate Hikes Are Reshaping Global Asset Pricing

Forex Market: The Logic Behind the US Dollar’s Strength

The mechanism behind the dollar’s appreciation due to rate hikes is straightforward—higher interest rates increase the yield on dollar assets, attracting global capital inflows into USD-denominated assets. In 2022, the US dollar index rose by 8.5%, reflecting this capital movement. For economies reliant on imports, a weaker local currency directly raises import costs, fueling inflation.

Stock Market: Dual Impact of Valuation Pressure and Capital Outflows

Stock markets are most sensitive to rate hikes. On one hand, rising interest rates directly lower company valuation multiples—asset pricing models show an inverse relationship between interest rates and valuations; on the other hand, higher financing costs erode corporate profits. In 2022, the S&P 500 declined by 17%, and the Nasdaq plunged by 30%, illustrating the direct impact of rate hikes.

However, in 2023, stock markets rebounded, reflecting market expectations that the rate hike cycle is nearing its end—investors are beginning to believe the Fed is close to pausing rate increases or even starting to cut rates. This indicates that factors influencing the stock market go far beyond rate hikes alone; shifts in policy expectations often trigger larger market reactions.

Gold: An Inverse Indicator of Expectations

Gold has an inverse relationship with rate expectations rather than with rates themselves. During the acceleration of rate hikes in the first half of 2022, gold prices continued to fall; but from mid-year onward, as the end of rate hikes approached, gold prices started to rise. This shows that market expectations of future policy directions have a greater influence on gold trends than the rate hikes themselves.

Bond Market: The Direct Victim of Interest Rate Environment

Bonds have a direct inverse relationship with interest rates—rising rates cause existing bond prices to fall. Part of last year’s banking crisis originated from this: large bond holdings by banks suffered significant unrealized losses during rate hikes, and under customer withdrawal pressures, they were forced to sell at low prices, creating a vicious cycle.

How Rate Hikes Deeply Transform Taiwan’s Economy

The Chain Reaction Triggered by Currency Depreciation

US rate hikes → US dollar appreciation → Taiwan dollar depreciation. This causal chain has a comprehensive impact on Taiwan’s economy. A weaker Taiwan dollar makes imports priced in USD more expensive. In 2022, food prices in Taiwan rose by 6%, with egg prices soaring by 26%. The main reason was the surge in feed costs (mainly imported from the US). The US accounts for 22.8% of Taiwan’s agricultural imports, so USD appreciation directly pushes up food inflation.

Although Taiwan’s central bank also raised interest rates, totaling 75 basis points, compared to the Fed’s 500 bps increase, its defensive capacity is insufficient, making it unable to effectively support the Taiwan dollar.

The Deeper Logic of Capital Outflows

Another serious consequence of currency depreciation is capital outflow. From the perspective of foreign investors: I exchange USD for TWD to invest in stocks, earning returns in USD. But if the TWD depreciates during this process, the USD return on stocks is actually negative. Under this expectation, rational investors will withdraw, leading to large-scale capital outflows. In 2022, Taiwan’s stock market experienced capital outflows of $41.6 billion, ranking first in Asia, illustrating this logic.

Stock Market Performance: Multiple Negative Factors Compound

Taiwan’s stock market faces multiple headwinds from rate hikes: foreign investors withdraw due to exchange rate risks, and higher domestic interest rates also lower stock valuations. In 2022, the Taiwan Weighted Index fell by 21%, ranking near the bottom globally—this is the result of multiple factors acting together.

However, not all stocks will face the same fate. Financial stocks benefit from the widening interest spread caused by rate hikes. For example, Taiwan Cooperative Bank saw a 38% increase in interest income in 2022, and its stock price rose by 20%. This suggests investors should dynamically adjust their strategies according to different stages of the rate hike cycle.

Investment Opportunities During the Rate Hike Cycle

Direct Opportunities from US Dollar Appreciation

The appreciation of the USD due to rate hikes is now a certainty. Going long on USD is the most direct strategy. There are various ways to invest in USD, from currency exchange at banks to derivatives trading. For retail investors with limited capital, leverage tools can amplify gains—just a small margin is needed to participate in the USD appreciation trend.

Structural Adjustments: Reduce Holdings of Growth Stocks, Increase High-Dividend Assets

In a rising interest rate environment, stock portfolios should be rebalanced. High-valuation growth stocks (especially tech stocks) are most sensitive to interest rates and should be reduced accordingly; meanwhile, high-dividend stocks (particularly financials) become attractive due to the widened interest spreads, warranting increased weight.

Use of Hedging Instruments

Investors unable to fully reduce their Taiwan stock holdings can hedge risks by shorting indices. The Taiwan Weighted Index and Nasdaq are highly positively correlated. By appropriately shorting US tech indices, investors can partially offset losses from a decline in Taiwan stocks.

Thinking About the End of the Rate Hike Cycle

Rate hikes are not a permanent norm. Historical experience shows that market reversals often occur near the end of a rate hike cycle—investors gradually realize that the policy endpoint is near, and risk assets begin to rebound. The key to navigating macro policy changes is to grasp different stages of the rate hike cycle and adjust investment strategies promptly.

While the specific timing of US rate hikes is becoming clearer, it is more important to understand the economic logic behind rate hikes and how they differentially impact various assets. For Taiwanese investors, the risks and opportunities brought by rate hikes coexist—success depends on whether they can accurately identify and adapt flexibly.