Fed to raise interest rates as soon as March: how to deal with financial market turmoil?

Continued high inflation in the United States has forced the Federal Reserve to continuously release tough policy signals in an attempt to reverse inflation expectations.

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Recently, the United States has successively released the CPI and PPI data for December 2021, both of which continue to “boom”. From a year-on-year perspective, the former rose by 7% and the latter by 9.7%, which further strengthened the market’s expectation that the Fed will raise interest rates ahead of schedule and accelerate . As one of the most "dovish" officials in the current Fed, Fed Governor Brainard has also changed his attitude and hinted at raising interest rates as soon as March.

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What kind of impact will the Fed’s monetary policy shift bring? On January 15, a number of scholars and market participants held discussions at the "Global Wealth Management Forum Shanghai Summit".

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The global interest rate center will rise

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Liu Liange, chairman of Bank of China, pointed out that global liquidity will face an inflection point in 2022. The Fed will speed up the tightening of monetary policy, and the market is expected to start raising interest rates as soon as March, and the time to shrink the balance sheet will also be earlier. The European Central Bank announced that it will end its emergency anti-epidemic bond purchase program in March 2022. Developed economies such as the United Kingdom, Norway, and New Zealand, as well as some emerging economies, have entered the rate hike cycle ahead of schedule. In 2022, the growth rate of global liquidity will slow down or even decline, and the global interest rate center will rise.

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Professor Philip H. Knight and Honorary Dean of Stanford University Business School, and Nobel Laureate in Economics Michael Spence said at the summit that the Federal Reserve is now in a dilemma. The situation in 2021 is changing very fast and demand is insufficient. The shift to supply constraints has put enormous pressure on the economy. Inflationary pressures will continue, and demand growth cannot be met as supply chains are affected. In this context, the long-lasting and far-reaching effects of inflation on major economies must be considered. All countries are facing the constraints brought by the epidemic to supply chains, major economies still need to deal with inflation, and the global asset-liability ratio remains high, and 2022 will be a year full of ups and downs. But with the effective control and end of the epidemic, the future will return to a trend with a potentially optimistic situation.

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Financial market volatility will become the main risk point

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Liu Liange believes that this change brings both opportunities and challenges to financial institutions. On the positive side, first, the rise in interest rates will improve the net interest margin of financial institutions and help improve the profitability of financial institutions. Second, the normalization of the Fed's monetary policy will boost the appreciation of the US dollar, and the return on US dollar assets will increase. Global financial institutions can improve their asset quality and profitability by adjusting their asset and liability structures. Third, the tightening of liquidity will help to stabilize the rising trend of global commodity prices and alleviate the problem of high inflation in developed economies from the money supply side.

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From a negative perspective, first, financial market volatility will become the main risk point. Asset prices in the stock market and bond market may undergo a sharp correction, corporate and household debt risks will increase, the default risk will increase, and the credit risk and liquidity risk of financial institutions may increase. Second, environmental changes in the financial sector will gradually spread to the real sector. The tightening of liquidity will reduce the risk appetite of financial institutions, which may bring new financing constraints to the real economy sector that has not yet recovered, and the probability of corporate credit and bond default will increase. The increase will bring certain challenges to the asset quality of financial institutions. Third, from past experience, the tightening global monetary environment has a far greater impact on emerging economies than developed economies. At present, some emerging economies have exposed obvious exchange rate fluctuations and sovereign debt risks, and changes in global liquidity in 2022 may trigger a new round of financial turmoil.

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"Financial institutions need to pay close attention to these risk changes and have pre-judgment plans." Liu Liange pointed out that special attention should be paid to the following matters: First, pay attention to changes in the total amount and structure of global liquidity, guide funds to flow to the real economy, and increase awareness of sustainable development, Green assets, digital economy and other fields support the transformation and upgrading of the economic structure. The second is to pay attention to the impact of changes in global mobility on the gap between the rich and the poor and income inequality, increase support for inclusive finance, small and micro enterprises and poor individuals, promote the realization of the strategic goals of the United Nations 2030 Agenda for Sustainable Development, and promote lasting, Inclusive and sustainable economic growth, narrowing the gap between the rich and the poor, and promoting global common prosperity. Third, the central banks of various countries strengthen the communication and coordination of monetary policies, reduce the spillover impact and unexpected impact on the global financial market, and create a more benign and stable development environment for the global economy and finance.

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Prepare for spillover risks

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Liu Jun, Deputy Secretary of the Party Committee and President of the Bank of Communications, called the curtain call of the quantitative easing policy one of the "big stones" in 2022. Beginning in 2021, especially in the second half of the year, inflation will come, and it will directly hit a new high. In an instant, the Fed's monetary policy makers quickly evolved from the dovish and hawkish divisions to the inflationary transitory and inflation-persistent divisions, and a series of recent news all point to a firm gesture of exiting the quantitative easing policy. And it's "fast rather than slow", "sooner rather than later". The timetable for the Fed's tapering of bond purchases will come to an end in the first quarter of this year, and the timing and number of interest rate hikes are moving forward and in more directions.

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Spencer believes that since the vaccination rate of emerging market countries is not high, the impact of the epidemic is still quite serious. Therefore, if central banks tighten monetary policy, there may be capital outflows from emerging markets, which will have a serious negative impact on the economy, and even There is also the potential for an economic crisis at the global level.

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“The last financial crisis was unanticipated and abrupt, so there was actually a lag in capital flows,” Spencer said. “In emerging markets, especially high-income emerging markets, they’re not that vulnerable. But Under the impact of this epidemic, many countries have not been able to control the epidemic, their vaccination rates are still relatively low, and they have relatively little room for financial and trade maneuvering, and they are in a fragile situation. These countries may be in debt. In this case, you will see more sovereign debt problems in these countries. At the central bank level, especially the Fed is likely to tighten monetary policy, this will be a very common pressure, but this will not necessarily be a systemic crisis in the global financial system.”

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"In a crisis, central banks remain cooperative," Spencer said, adding that even if there is some political interference that prevents central banks from cooperating, whether in China, Europe or the United States, central bank staff are experienced Rich teams, they are sure to avoid systemic instability by working together.

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Liu Jun further pointed out that such a curtain call of quantitative easing is a cyclical squeeze of funds and an instant withdrawal of liquidity for emerging markets, and the intensity will not be weak, the magnitude will not be small, and emerging economies will be hit harder. Also more pronounced. China is already warning and preparing for such spillover risks, not only the forward-looking management of compound inflation in which supply shortage, demand-pull, and cost-push are superimposed, but also the triple pressure of demand contraction, supply shock, and weakening expectations. Effective release and high quality hedging.