Federal Reserve raises rates, signals further hikes, impacting global markets

Jeenah Moon | Reuters

The U.S. Federal Reserve is tightening monetary policy, and the effects are likely to be felt far beyond the American shores.

The Fed on Wednesday raised interest rates for the first time since July 2023 and indicated another hike could follow, as part of its effort aimed at combating inflation that has been stoked by spiraling oil prices, among other factors.

For global markets, a renewed U.S. tightening cycle could mean a stronger dollar, greater pressure on currencies elsewhere and less room for other central banks to ease monetary policy, experts told CNBC.

Higher U.S. rates could also keep global bond yields elevated and weigh on equity valuations and economic growth.

The Fed's hike and signals about another one are putting some upward pressure on the dollar and downward pressure on other currencies, Mark Zandi, chief economist at Moody's Analytics, told CNBC.

Pressuring currencies

One of the most immediate channels through which a tighter Fed policy travels around the world is the dollar.

Higher U.S. rates support the greenback while putting pressure on other currencies, as major assets such as oil and natural gas as well as agricultural commodities are priced in dollars.

That "does create stresses around the world," Zandi said, particularly for economies whose currencies or monetary policies are closely tied to U.S. rates.

Japan is one market in focus. A weaker yen could add to the case for further tightening by the Bank of Japan, he elaborated. "It does put pressure on Japan to continue to follow suit and raise interest rates as well," he said.

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Navin Saigal, BlackRock's head of global fixed income for Asia Pacific, echoed that the market's hawkish interpretation of the Fed meeting "may put some pressure on Asian currencies and bond markets in the near term."

Currency weakness can also complicate central banks' inflation fight by raising the local-currency cost of imported goods.

That comes as oil prices have already risen sharply due to the Middle East conflict, creating the prospect that some economies could simultaneously face higher energy costs, weaker currencies and elevated interest rates.

Influencing policy

The Fed's shift also comes as several major developed-market central banks are in the process of tightening policy.

The European Central Bank raised rates by 25 basis points last week, while J.P. Morgan Asset Management expects the Bank of Japan to increase rates by a quarter point this week.

"Developed market central banks are in sync with tightening monetary policy to address inflation concerns," said Tai Hui, APAC chief market strategist at J.P. Morgan Asset Management.

Higher rates-led rise in Treasury yields also raises prospects of capital outflows from other markets into the U.S., creating pressure on central banks to respond.

Still, Fed's move do not necessarily mean a synchronized global hiking cycle.

Inflation conditions across Asia are unusually divergent. China and Thailand continue to face deflationary pressure, while inflation in Australia and Japan remains above central-bank targets. India's inflation, meanwhile, sits around the middle of the Reserve Bank of India's target range, according to BlackRock.

That means domestic conditions could ultimately outweigh pressure to mechanically follow the Fed, even as a stronger dollar reduces policymakers' room to ease.

Market impact

For markets, a prolonged period of higher rates also raises the hurdle for equities and other risk assets.

Higher government bond yields make fixed-income assets more competitive compared with stocks while increasing companies' financing costs and reducing the present value investors place on future earnings.

Liz Ann Sonders, chief investment strategist at Charles Schwab, said the level of yields may matter less than the speed and orderliness of their rise. She said the 10-year Treasury's move toward 5% was broadly justified by inflation, expectations for Fed policy and strong nominal economic growth.

"I think if the yield move were to start to get disorderly, then I think you have a bigger digestion problem for the equity market, but I think the economy and the market can, to some degree, handle this if it remains orderly," Sonders told CNBC.

The pressure is also unlikely to be evenly distributed. Sonders said higher rates were already hitting more cyclical areas of the market, while strong earnings could complicate the inflation outlook by supporting hiring.

JPMorgan's Hui said investors may need to reassess valuations if the Fed remains hawkish into 2027, particularly for technology stocks that are relatively sensitive to interest rates.

Higher U.S. rates are only one side of the equation for global markets. The resilient U.S. economy that has given the Fed room to tighten could also support demand for exports and corporate activity elsewhere.

BlackRock's Saigal said strong U.S. growth should continue spurring global activity, trade flows and corporate fundamentals across Asia, even as higher rates create near-term pressure.