Jan 11, 2023

The Fed raising interest rates means it will be more attractive to use the US dollar instead of other currencies. Domestic funds and funds from some foreign companies will flow into the US markets, which is a crucial aspect of the US investment market. At the same time, higher rates are likely to cause the appreciation of the US dollar. In addition, the Fed’s interest rate hikes tend to raise the deposit rates offered by American banks. Many intelligent investors from the US and abroad will choose to deposit their money in American banks. The US stock market will fluctuate, causing stock prices to fall, but from a broad perspective, the Fed’s rate hikes on the US economy has more pros than cons. 


How Fed Rate Hikes Affect Stock Markets

  1. For the US stock market, rising interest rates will increase the interest rate paid on bank deposits. Hence, investors will choose to deposit their money in banks, which will drastically reduce the number of funds flowing into the stock market;
  1. For China’s stock market, the inflow of capital into the US stock markets will lower the investment in Chinese stocks, and their stock prices will likely fall, impacting the global stock markets.
  1. When the Federal Reserve raises interest rates, mainland funds or foreign capital will flow into the US markets. As a result, once the dollar appreciates, the RMB will likely depreciate, and the cost of purchasing raw materials for Chinese companies will increase.

How Fed Rate Hikes Affect Forex Markets

If the Federal Reserve raises interest rates, it makes assets quoted in the US dollar very sought after, as the US dollar appreciates significantly. The value of each country’s currency will likely decline amid the increasing propensity of investors to purchase US dollar assets, which will also significantly impact a country’s capital flow. But most of the time, after the Fed announced a rate hike in the foreign exchange market, the dollar did not move higher.

The main reason for the above is that the foreign exchange market has certain expectations for the US dollar about raising interest rates. The markets keep track of various aspects, such as the economic situation in the United States and the speeches made by Fed members before the rate hikes. At this time, the foreign exchange market may have already concluded that the US dollar is about to experience higher interest rates. Hence, there would be a lot of information about the direction of the US dollar interest rate hike in the foreign exchange market. When the US Fed finally raises interest rates, the market may have already priced in the impact of this interest rate hike on the foreign exchange market. Therefore, when the Fed makes the actual announcement, it will not react significantly. On the other hand, if the Federal Reserve does not announce an interest rate hike, the market may have a relatively large reaction, given that it was expecting a rate hike.

What impact will the Fed rate hike have on the forex market?

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  1. The Fed raises interest rates, which means that the US dollar enters a strong channel, and the currencies and commodities linked to the US dollar will depreciate;
  1. The higher interest rates create a strong impetus for international capital to flow into the United States;
  1. Countries supported by the US dollar-denominated capital will face the risk of capital pumping and capital flight;
  1. It shows that the Fed is optimistic about the economic development of the United States because it needs to adopt tighter monetary policies to suppress the economy’s overall momentum;
  1. Overall, the US dollar interest rate hike is good for the US dollar, making the US dollar index rise.

A Fed rate hike means an increase in the federal funds rate, which is the rate at which commercial banks lend money to each other. The higher interest rates have a substantial impact on the interest rates paid by commercial banks, affecting the interest rates offered by banks.

When the Fed raises interest rates, banks will also increase the interest on user deposits. Therefore, foreign exchange investors prefer to hold US dollars over other currencies. As international funds pour into the United States in search of higher yields, the US dollar will be stronger in the foreign exchange market and appreciate relative to other currencies. Therefore, other currencies will depreciate against the US dollar.

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