The shock wave of the Federal Reserve's “hawkish interest rate hike”: the “triple strangulation” of a strong dollar, high oil prices, and high interest rates. The Asian foreign exchange market faces another capital outflow storm

The Zhitong Finance App learned that as the Federal Reserve raised the benchmark interest rate for the first time after a lapse of three years and two months, and international oil prices continue to stand above $100, emerging economies may once again face the triple burden of “high oil prices, strong dollars, and high interest rates.” Market strategists warned that the Federal Reserve's hawkish rate hike would put pressure on Asian currencies, especially the yen before the Bank of Japan meeting on Friday.

Earlier, the Federal Reserve announced that it would raise the benchmark interest rate from 3.50%-3.75% to 3.75%-4.00%. Meanwhile, out of 18 officials predicting future interest rate paths, 16 expect at least one more rate hike this year. The market is sensitive to consistent rate hikes and the possibility of further tightening. The US dollar index, which measures the US dollar against six major currencies, including the euro and yen, hit a seven-week high.

Shima Shah, chief global strategist at Principal Asset Management, said: “The focus of the current debate has shifted from 'whether to raise interest rates' to 'how many times to increase'.” She pointed out that this unanimous vote “shows that due to rising energy prices and stubborn inflation, even doves have joined the hawkish camp.” Further interest rate hikes could increase the pressure that emerging markets are already under due to high oil prices, strong dollars, and expensive borrowing.

Emerging markets face capital outflows, currency depreciation, and rising debt service costs

A rise in US interest rates means a shift in global investment flows. When safer assets such as US Treasury bonds provide higher returns, investors are less willing to invest in emerging market stocks or bonds. Capital outflows from emerging economies weaken their currencies and increase debt repayment costs for businesses and governments that borrow in dollars.

Asia is also facing additional pressure on oil prices due to the war in Iran. About 80% of the oil shipped through the Strait of Hormuz flows to Asia, and Asian countries such as South Korea rely on imports for almost all of their oil. Since oil is denominated in US dollars, the price of oil rises at the same time as the US dollar, which means that importing the same amount of oil requires a higher cost. Import prices have risen, making it more difficult for major central banks to stimulate growth by cutting interest rates.

Currently, the war in Iran has hit the Asian foreign exchange market. In May, the Indonesian rupiah fell to an all-time low of 17,745 against the US dollar. The Indian rupee has fallen by more than 6% this year, and foreign capital has fled the Indian stock market since the war began. The Philippine peso also fell to an all-time low, reflecting the general weakness of Asian currencies.

Historical mirror: Emerging markets all experienced severe shocks in 1994, 2013, and 2022

This is not the first time that aggressive US austerity has shaken global markets.

In 1994, the Federal Reserve preemptively raised interest rates from 3% to 6% within a year to curb inflation amid rapid economic growth. Emerging markets have had to offer higher yields to retain investors, and the spread between interest rates on their bonds and US Treasury bonds widened to 8 percent. This has caused borrowing costs in emerging economies to soar. Mexico's peso, which is heavily dependent on foreign capital, plummeted by nearly 30% in 10 days at the end of 1994, triggering a financial crisis.

In 2013, even without interest rate hikes, the market fluctuated violently. After the 2008 financial crisis, the Federal Reserve kept interest rates close to zero and purchased $85 billion in bonds every month. As the US job market recovered, then-Chairman Bernanke hinted that debt purchases would be cut. This hint alone nearly doubled the 10-year US Treasury yield to 3%, triggering a “Taper Tantrum” (Taper Tantrum), and capital fleeing emerging markets. In December of that year, the Federal Reserve began reducing the monthly debt purchase scale from 85 billion US dollars to 75 billion US dollars.

In 2022, the Federal Reserve aggressively raised interest rates to counter supply chain disruptions and soaring energy prices caused by the Russian-Ukrainian conflict. Interest rates rose from 0-0.25% to 4.25% to 4.50% within nine months, increasing by 4 percentage points cumulatively. By October, the dollar had risen about 6% against emerging market currencies. The International Monetary Fund (IMF) estimates that a 10% appreciation of the US dollar may increase inflation in other countries by about 1 percentage point.

This year is the same as 2022: the Federal Reserve raised interest rates at a time when the war drove oil prices to soar. Although the massive austerity cycle remains uncertain, the Federal Reserve is open to further rate hikes, indicating that the tightening may be extended.

Strategist: Asian currencies are under pressure, and the yen is at the center of the storm

The Federal Reserve's hawkish rate hike is expected to suppress Asian currencies, particularly the yen before the Bank of Japan's monetary policy meeting on Friday. The strategist said that the yen may weaken to the 200-day EMA (about 158), while bond yields will be dominated by the trend of US bonds. Stocks, particularly those that are interest rate sensitive, are under pressure.

Tim Waterer, chief market analyst at KCM Trade, said: “Given the new level of hawkiness shown by the Federal Reserve, tension in the Asian market is likely to persist.” He also pointed out that there is at least one more rate hike in this round. Yields and the US dollar have already risen, while growth-sensitive assets such as stocks have an unstable foundation because tighter monetary conditions are still in preparation.

Bank of Australia and New Zealand (ANZ)'s Khoon Goh said that Asia's current-account deficit currencies will face greater pressure because higher US interest rates mean it will be more challenging to attract inflows to finance deficits, especially with the recent rise in oil prices. The Philippine peso and Indian rupee are likely to hit record lows again, and the Indonesian rupiah will take back some of the recent gains. As Thailand recently joined the current account deficit camp, the Thai baht will weaken further in the near future. The Taiwan dollar and won are expected to be strong, and the won is supported by continued exporters' exchange flows.

Glenn Yin of ACCM Prime said, “There is no doubt that Japan is under tremendous pressure not only to raise interest rates, but also to send hawkish information to minimize damage. In particular, the Federal Reserve's economic forecast summary shows another rate hike before the end of the year.” Given that Japan has intervened many times to support the yen, the dollar will rise again against the yen if the Bank of Japan does not send hawkish messages and raise interest rates tomorrow. “The risk of hitting the 160 level in the short term cannot be ruled out.”

He also pointed out that the Federal Reserve's restart of the austerity cycle is eroding the attractiveness of the Australian dollar, even though the Reserve Bank of Australia's cash interest rate is relatively high. “I think that, combined with high energy prices and anticipated inflation prospects, this will give the Reserve Bank of Australia a specific reason to raise interest rates before the end of the month.”

Nick Twidale of AT Global Markets said: “As the day progresses, we will see an appreciation of the dollar against the yen, although traders will be wary of long positions in light of recent trends.”

“The main update on interest rate spreads now will be how hawkish the Bank of Japan is on Friday.” He expects USD/JPY to test the 200-day EMA around 158.40. As the Bank of Japan's interest rate hike is now a foregone conclusion, “everything depends on the details of the statement and press conference. I do expect them to be hawkish, and I think this will lead to some yen buying on Friday.”

eToro's Josh Gilbert said, “Funding will stay expensive for longer than anyone else in the region plans, and it's the semiconductor and AI names that are carrying exponential returns this year,” said Josh Gilbert of eToro. “The investment logic in Asia hasn't changed overnight, and investors will have to be more picky to see which companies can actually profit in a higher interest rate environment.”

Hebe Chen of Vantage Global Prime said that for the bond market, the Fed's actions may cast a long shadow rather than create a brief storm. “The storm will pass; higher capital costs will remain, and this part may continue to put pressure on valuations long after today's reaction.”

Asia is directly in this shadow. Higher US bond yields and a stronger dollar could pull capital back to the US, suppress regional currency and local bond markets, and make Asian central banks less room for easing; while high-term stock markets such as South Korea and Taiwan are particularly sensitive due to their high-tech exposure. “Looking further, this doesn't necessarily mean a straight-line sell-off, but it does change the equation: valuation buffers are getting thinner, capital costs are getting heavier, and profits will increasingly have to support the market alone,” Chen added.

Joe Unwin of Apostle Funds Management said that the Federal Reserve's hawkish tone should put upward pressure on Australian government bond yields. “Although the two markets may not necessarily change simultaneously, the Fed's decision indicates that the global interest rate cut cycle is over and that the rate hike cycle may have begun. This provides a more favorable environment for the Reserve Bank of Australia to raise interest rates further and will boost Australian bond yields.” The Fed's rate hike will be a headwind for all stock markets, and Australia is no exception. Interest rate sensitive parts of the market are likely to be affected the most, such as REITs or high-valued growth companies.

Phillip Wool of Rayliant Global Advisors said that the more aggressive the Federal Reserve tightens, the greater the pressure on the Bank of Japan to speed up the pace of interest rate hikes. On the face of it, Walsh's hawkish signals since Jackson Hole, and now the FOMC's latest forecast shows higher long-term policy interest rates, seem to be negative factors. “The USD/JPY may continue to strengthen, but policymakers are clearly aware of the risk of continuing imbalances, so the Bank of Japan is expected to send a hawkish message and slow down the dollar's momentum.”

Jung In Yun of Fibonacci Asset Management Global expects both the Bank of Korea and the Bank of Japan to raise interest rates, and believes that the relative policy path is more important for the currency. “My position is selective investment, preferring Korean technology companies with low valuation multiples, steady profit growth, and sustainable growth.”

Aozora Bank's Akira Moroga said that the Bank of Japan is expected to follow the Federal Reserve's interest rate hike, but it may not take a hawkish stance like the Federal Reserve, which may be an immediate catalyst for the weakening of the yen. America's strong commitment to curbing the weakening yen is acting as a limiting factor, and a further drop to 160 yen may be avoided. “We maintain the view that the yen will stabilize at around 155 yen by the end of the year.”

Pepperstone Group's Dilin Wu said, “For stocks, hawkish bitmaps raise actual discount rate risk — and this is a pressure point for high-multiples of AI and technology stocks that are driving gains this year. If the Federal Reserve actually raises interest rates again before December, it will be an important medium-term headwind worth watching.” As far as bonds are concerned, the key in the next few weeks depends on whether the 10-year US Treasury yield actually falls back from the 5% area or whether it is once again polished back to that level. This result will tell the market whether this rate hike is a credible anti-inflation measure, or whether the Federal Reserve is catching up with a bond market that it actually has no control over.

Tohru Sasaki of Fukuoka Financial Group said that the threshold for the Bank of Japan to avoid disappointing hawkish expectations in the market has been raised. If Governor Ueda Kazuo makes enough hawkish remarks to meet market expectations, the dollar may fall to about 155 yen against the yen. On the other hand, if the Bank of Japan fails to meet market expectations, the US dollar may rise to the mid-range of 158 yen, where the 200-day EMA is located.