Facing the prospect of significant interest rate increases in the US, the yield on the 10-year Treasury bond has at times risen to 4% – the highest since 2010. A global wave of stock sell-offs is taking place, and bond investment portfolios have also lost 21% since the beginning of the year – a stunningly high level.
The international financial market is experiencing the most painful adjustment since the financial crisis
Meanwhile, the USD is “crushing” all its competitors. The greenback has risen nearly 5.5% since mid-August, not only due to the Federal Reserve’s interest rate hike, but also because investors are turning their backs on risky assets.
Across Asia, governments are working hard to prevent their currencies from depreciating too deeply. In Europe, the UK’s careless management of fiscal policy has eroded investor confidence. With rising bond yields, heavily indebted economies in the Eurozone are at their most fragile state since 2012 – when they were mired in the sovereign debt crisis.
The main cause of the market turmoil is the Fed’s battle against inflation. Having lost ground to the wave of rising prices since inflation peaked earlier this year, the Fed is now facing even more challenges. Fed officials are planning to raise the federal funds rate to nearly 4.5% by the end of this year and even higher in 2023.
The prospect of rising interest rates is pervading and deeply affecting the U.S. financial system. The interest rate on a 30-year mortgage has risen to nearly 7%. The yield on junk bonds has risen to over 9%, causing a serious decline in new debt issuance.
Brokers who guaranteed leveraged buyout deals during low interest rates suddenly realized that they were losing hundreds of millions of dollars. Retirement funds that focused on private assets to earn high returns are now suffering losses due to sharp declines in risky assets.
Outside of the US is where the impact of the Fed’s tightening monetary policy is felt the most.
The USD’s appreciation has caused energy importers to suffer, despite already facing relentless price hikes. To protect their domestic currency, China has implemented policies that make it difficult for investors to sell the renminbi. On September 28th, offshore renminbi fell to its lowest level against the USD.
India, Thailand, and Singapore have all intervened in the financial markets to protect their respective currencies. According to JPMorgan Chase’s data, the foreign exchange reserves of newly emerging economies, excluding China, have decreased by over $200 billion from the beginning of the year to the present day – the sharpest decline in two decades.
Typically, developed economies can always adapt to a strong USD, but some cracks have started to appear. Several currencies in this group, including some domestic currencies, are on the list of the worst-performing currencies in 2022. On September 20th, Sweden had to raise interest rates by 1%, but its domestic currency is still declining against the USD.
One of the reasons why currencies of developing economies are under pressure is that many central banks are unable to keep up with the pace of the Fed’s monetary tightening.
According to The Economist, the energy crisis will soon push Europe into a recession. South Korea and Japan will be affected by China’s economic slowdown. The world’s second-largest economy is facing two prominent issues: the pandemic and the real estate market.
The strong US dollar is exporting the country’s inflation problem to weaker economies. These economies may support their currencies by increasing interest rates corresponding to the Federal Reserve (Fed), but the cost will be lower growth. The UK is a typical example.
The market predicts that the UK will raise interest rates to the highest level among developed economies next year, but the pound has depreciated significantly. If developed economies continue to act, the UK housing market may collapse.
e resilience to the headwinds that have continuously hit the global economy since the beginning of the year, is predicted to find it difficult to withstand the interest rate shock. House prices are falling, albeit not sharply, and many banks are laying off staff. Two companies that are considered “barometers” of the US economy, FedEx and Ford, have recently issued profit warnings.
It is only a matter of time before US unemployment rates begin to rise. A slower-growing economy will immediately help stabilize prices. It would be “madness” if the Fed accepted an inflation rate of up to 8.3% per year. However, rising interest rates will cause more harm to the economy.
