Impact of Fed rate hikes

Among the central banks around the world, the Federal Reserve should be the one that gets the most attention. received global attention. Because of the enormous influence of the U.S. economy in the global economy and the hegemony of the U.S. dollar, the Fed’s interest rate hike or cut will trigger changes in global capital flows and economic fluctuations.

Why does the Fed keep raising interest rates?

After the outbreak of the 2008 financial crisis, the Federal Reserve in December 2008 will The federal funds rate is determined at 0–0.25%. On August 9, 2011, the Federal Reserve announced that it would maintain the federal funds rate at 0–0.25%. In December 2015, the Federal Reserve began to raise interest rates.

By December 20, 2018, the Federal Reserve announced another 25 basis point rate hike. The funds rate was raised to 2.25%-2.5%, which is the ninth rate hike by the Federal Reserve since December 2015. The Fed’s reason for raising interest rates is that the United States has recovered from the 2008 financial crisis and its economic growth is relatively strong.

For example, as of May 2019, the U.S. economy has expanded 119 consecutive If the U.S. economic growth can continue until July 2019, it will break the historical record of 121 consecutive months of U.S. economic growth during peacetime. Meanwhile, the U.S. unemployment rate fell below 4% in April 2019, falling to 3.6%, the lowest unemployment rate in the past 50 years.

The US stock market began to rise on March 9, 2009 and continued until 2018 At the end of the year, it experienced the longest bull market in the history of the United States, during which the Dow Jones index continued to hit new highs. The continued prosperity of the U.S. economy has led the Federal Reserve to believe that there may be a risk of inflation in the U.S. economy. If the economic growth rate is too fast, the enterprise may invest too much, purchase a large amount of raw materials, and hire a large number of employees, but the supply of raw materials and labor may not be enough, resulting in an increase in the price of raw materials and wages of employees, which eventually leads to Prices rise, inflation occurs.

As the U.S. economy continues to grow, in order to prevent inflation from In December 2015, it began to raise interest rates, that is, to increase the federal funds rate to cool down the overheated economy.

The impact of the Federal Reserve’s interest rate hike on the US economy

In the United States, although the Federal Reserve cannot decide the deposit and lending rates of commercial banks and the interest rates on the capital market, It can still affect the deposit and lending rates of commercial banks and the interest rates of the capital market, mainly because it can determine two benchmark interest rates, namely the federal funds rate and the discount rate. The federal funds rate is the interest rate at which financial institutions in the United States borrow money from each other, and the discount rate is the interest rate at which commercial banks borrow money from the Federal Reserve.

Among them, the federal funds rate is more important. The Federal Reserve uses its own monetary policy to influence the federal funds rate. The federal funds rate it determines is usually a range, and the specific amount is determined by free bargaining among commercial banks. So, how does the Federal Reserve affect interest rates in the market through the federal funds rate?

If the federal funds rate is 1%, the interest rate that Citibank borrows from HSBC is 1%. Citigroup, on the other hand, charges 4% interest rate to other companies when it re-lends the funds it borrows from HSBC to other companies. Now, the Federal Reserve has raised the federal funds rate from 1% to 2%, and when Citibank lends money borrowed from HSBC to other companies, the interest rate will be increased by at least about 1%, that is, from the original 4%. to about 5%. This is how the Fed indirectly affects interest rates in the market by setting the federal funds rate.

After the Federal Reserve raises the federal funds rate, inter-bank borrowing rates rise, so companies pay to banks The interest rate on the loan has also risen. With the rise of loan interest rates, companies are likely to reduce loans or not to lend. In this way, the investment of enterprises will decrease, the overheated economy will gradually cool down, and the risk of inflation will also decrease.

Regarding the Federal Reserve’s continuous interest rate hikes, former US President Trump repeatedly Three places attacked. Since the Fed started raising interest rates, Trump has accused the Fed more than 10 times. At the end of November 2018, US media reported that Trump even considered firing Fed Chairman Powell, although Powell was nominated by Trump in November 2017 to be the chairman of the Federal Reserve.

The reason why Trump is dissatisfied with the Fed and Powell is because he believes that the Fed will raise interest rates slowed the growth of the U.S. economy. The annual GDP growth rate of the United States in 2018 was 2.9%, which is the highest growth rate of the US economy since 2015. However, Trump tweeted that “if it weren’t for the Fed, the growth rate could have reached 4%”.

Largest government bankruptcy in U.S. history

In 1994, the largest government bankruptcy case in American history occurred in the United States, that is, the bankruptcy of Orange County. Orange County is a county near Los Angeles, very rich. How did the county go bankrupt? County Treasurers invest about $22 billion in the bond market, purchasing a variety of bonds including U.S. Treasury bonds, municipal bonds, financial bonds and corporate bonds. And leverage was added, which means that part of the $22 billion was borrowed.

There are two major risks in investing in bonds. One is the risk of default, that is, the issuer of the bond is unable or refuses to pay interest and principal ; The second is interest rate risk, if the interest rate rises, the price of the bond will fall immediately. These two risks are also two factors that affect bond prices.

In 1994, the U.S. economy had recovered from the 1991 recession. It began to raise interest rates and raised interest rates seven times in a row, causing the federal funds rate to rise from 3.5% at the beginning of the year to 6.75% in November. The rise in interest rates caused an avalanche of bond prices to fall. Orange County lost about $2.1 billion on its $22 billion bond investment and eventually declared bankruptcy. In 1994, the Federal Reserve’s continuous interest rate hikes also caused Goldman Sachs’ net profit to drop sharply year-on-year, and the annual net profit was less than 200 million US dollars.

China’s treasury bond futures first limit down

On December 15, 2016, an unprecedented thing happened in China’s bond market, that is, treasury bond futures of various maturities All closed with a lower limit, and some of the deadlines even opened with a lower limit. China’s treasury bond futures trading began in 1992. Due to the “327” treasury bond futures incident and other violations in 1995, in May 1995, the China Securities Regulatory Commission issued a notice to suspend treasury bond futures trading. In September 2013, the China Securities Regulatory Commission resumed treasury bond futures trading. Until December 2016 when treasury bond futures fell to the limit, the actual trading time of treasury bond futures was about 6 years.

There are many reasons why the treasury bond futures all fell to the limit this time, but one of the important reasons is that the Federal Reserve hike. On December 14, 2016, the Fed announced an interest rate hike of 0.25%. More importantly, the Federal Reserve said in its resolution that it expects to raise interest rates three times in 2017, far exceeding the original market expectations.

Why does the Fed’s interest rate hike become the reason for the limit-down of Chinese treasury bond futures? After the Federal Reserve raised interest rates, the rate of return in the U.S. capital market rose. In order to pursue higher rates of return, funds will leave other countries and go to the United States. In China, everyone is worried that the People’s Bank of China may continue to raise interest rates in order to attract funds to stay in China.

As we said earlier, one of the two major factors affecting bond prices is interest rates, if If the People’s Bank of China raises interest rates accordingly, the prices of spot and futures treasury bonds will definitely drop sharply.

Follow us and grow together. This article was first published by “Mr. Jin Yi 2022”, and the WeChat public account has the same name.