Interest rates

Will the US Fed raise interest rates by 100 basis points? The market is scared

Illustration: Chen Xia/Global Times

Stock markets around the world fell sharply last week amid growing expectations of hawkish interest rate hikes from the US Federal Reserve to rein in the country’s persistently high inflation. Investors are nervous as the US central bank prepares for its policy decision this week, with some starting to prepare for a big surprise.

It is possible that the Fed could announce a full one percentage point rate hike. The bank has already raised federal funds rates four times since the start of 2022, but US inflation remains at 8.3% annualized growth for August, which is still near four-decade highs. Some economists have warned the Fed that it is coming late to the game and that the central bank must decide on a 100 basis point hike to bolster the agency’s credibility.

But investors are still spooked by interest rate hikes, because higher rates often mean an increase in the cost of borrowing for businesses and, therefore, lower corporate profits and stock prices.

On Tuesday, when US inflation figures for August came out, above the broad market estimate at an increase of 7.9 or 8%, Wall Street suffered a frightening rout, with the Dow Jones Industrial Average plunging 1 276 points, or 3.9%. The S&P 500 index fell 4.3%, while the Nasdaq Composite plunged 5.2%. All three indexes were higher before the inflation data was announced, and they even posted gains for four consecutive sessions before Tuesday.

More bad news on Friday came as corporate warnings paint an increasingly bleak outlook for the U.S. economy. FedEx said it was closing offices and cutting jobs to compensate for falling market demand, heightening fears of a looming recession. The Dow Jones index fell another 0.5% on Friday.

Equity investors fear that sky-high US inflation in August means that even a drastic tightening of monetary policy is on the way, and their earlier expectation for price pressures to ease in the summer has proven short-lived. Now is not the time to end the tightening cycle of global central banks. The August inflation report now confirms that the United States still has a lot of work to do to crush consumer price increases and bring its annual inflation back to the preferred level of 2-3%.

During a policy speech at the annual meeting in Jackson Hole, Wyoming in late August, Fed Chairman Jerome Powell said U.S. monetary policymakers were very focused on containing rising prices.

“Reducing inflation will likely require a prolonged period of below-trend growth,” Powell said, adding that the bank needed to keep raising interest rates to prevent inflation from becoming a permanent feature of the economy. American economy. “While higher interest rates, slower growth and looser labor market conditions will reduce inflation, they will also hurt households and businesses,” he said.

Powell warned that a failure to restore price stability would mean “far greater pain” for Americans. He conceded that controlling inflation would come at a cost to vast American households and businesses, but argued it was “a price worth paying.”

Now, stubbornly high inflation data predicts that the US central bank will become even more aggressive in tightening policy. Last week’s alarming figure was the last before policymakers gather for their next rate decision. Markets have already anticipated that in September the Fed will raise interest rates by at least three-quarters of a percentage point for the third consecutive time this year. There is a growing risk that the Fed won’t take its feet off the accelerator to fight inflation anytime soon, and it will take much longer than expected for the bank to pause rate hikes.

As the Fed continues to tighten monetary policy, other central banks in Europe, Asia-Pacific, Africa and South America will continue to raise interest rates to curb their own inflation, and at the same time to prevent capital from being diverted to the US.

Lately, the value of the US dollar has risen with consecutive Fed rate hikes. The dollar index, which measures the greenback against a basket of other major currencies, has risen steadily to near 110. As U.S. dollar-denominated assets increase their returns, capital from other countries are drawn to the United States, leading to a wide range of very negative impacts on emerging market economies, such as currency depreciation, stock market crashes, and even government debt defaults.

The strong US inflation data and the Fed’s determination to continue policy tightening by raising interest rates, along with the depreciation of the Chinese yuan to break the psychologically important 7 against the dollar , sent shockwaves through the Chinese stock market last week. The Shanghai Composite stock index plunged 73.5 points, or 2.3%, to close at 3126.4 points on Friday. The index has fallen more than 15% so far this year.

Faced with growing uncertainties overseas and a persistent slowdown in the domestic housing market, the Chinese economy has yet to be fully activated. House prices continue to fall in most of China’s 70 major cities, except for Beijing and Shanghai, according to the latest official data. Bolder measures, including allocating a significant fund to help debt-ridden developers complete stalled housing projects, which should help house sales and prices stabilize before the end of the year, are required. After all, a revitalized housing market will propel the economy back into healthy growth mode.

The author is an editor at the Global Times. [email protected]