Although the global interest rate hike is spreading, the effect of interest rate hike on inflation in various countries is not obvious, and the pressure of imported inflation still exists.

Influenced by the expected rise of the Federal Reserve's interest rate hike, the dollar index broke through 109 on August 29, hitting a new high in nearly 20 years. Against the background of the sharp appreciation of the US dollar, the return on risk assets in the United States was under pressure, and the overseas operating income of enterprises declined. In addition, the appreciation of the US dollar has also exacerbated emerging market debt risks, capital outflows, short-term fluctuations in the RMB exchange rate, etc.

Reasons for the record high US dollar

The direct reason why the US dollar index reached a new high is that the Federal Reserve started a radical interest rate raising cycle to curb inflation in Qualcomm (126.65, 1.70, 1.36%). In addition, a better economic recovery in the United States, increased risk aversion in the market and the weakness of non US currencies are also driving factors for the US dollar to reach a new high.

First, the Federal Reserve stepped into a radical interest rate increase cycle. Since 2022, the Federal Reserve has raised interest rates four times, two of which reached 75 basis points. In July, the US consumer price index (CPI) rose 8.5% year on year, down 0.6 percentage points from June. Although it has declined, it is still at a high level in the past 40 years. On August 26, Powell publicly said that the Federal Reserve would firmly fight against high inflation, releasing the hawkish signal that it might continue to raise interest rates at the September interest rate meeting. Under the background of continuous interest rate increase by the Federal Reserve, short-term interest margin has become the main driver of capital flow, which has driven the dollar index up.

Second, the economic fundamentals of the United States are better than those of the euro area. Thanks to strong fiscal and monetary policies, the inflation containment and economic recovery of the United States are better than those of the euro area countries. The market is obviously bearish on the euro, driving the appreciation of the dollar. In terms of inflation, the US consumer price index (CPI) rose 8.5% year-on-year in July, lower than the 8.7% expected by the market. In July, the euro area CPI hit a record high, up 8.9% year on year. In terms of economy, the risk of recession in the euro area has risen, especially in Germany, France and Italy. On August 1, IHS Markit announced that the final value of manufacturing PMI in the euro area in July was 49.8, which was below the boom and bust line.

Third, the risk aversion in the market boosted the US dollar. At the beginning of this year, the Russian Ukrainian conflict triggered geopolitical risks, and the US dollar initially appreciated. As the epidemic continues, many countries have started a cycle of interest rate increases to curb high inflation, but it has had little effect. The market is still worried about the economic downside risks brought by interest rate hikes, and the risk aversion of the market has increased. Due to the safe haven nature of the US dollar and the large scale and high liquidity of the US treasury market, countries regard US bonds as the best choice for official reserves. Therefore, when market volatility intensifies and the risk of economic downturn increases, investors from all countries choose more US dollars to invest, thus ensuring the security and stability of funds.

Fourth, the African American currency is weak. The weakness of non US currencies such as the euro and sterling gave the US dollar index an upward momentum. According to relevant survey data, JPMorgan Chase (118.16, 1.08, 0.92%) predicted that by December, the euro would fall to $0.95, and the capital market of Royal Bank of Canada (96.26, 0.95, 1.00%) predicted that the pound would fall by more than 5% over the same period. In the dollar index, the euro accounts for 57.6% against the dollar, so the weakness of the euro has also driven the dollar index up to a large extent.

Impact on the United States

First of all, the strong US dollar attracts domestic funds to deposit in high security financial products such as bank deposits and US bonds, and risk assets and stock returns are under pressure. On August 29, the market continued to digest the signal of the Federal Reserve's interest rate increase, and the US stock jumped short and opened low. The Dow fell nearly 100 points at the opening, while the Nasdaq fell more than 120 points, led by technology and chip stocks.

Second, a stronger dollar will help the Federal Reserve achieve its goal of reducing inflation. A stronger US dollar will help curb US domestic inflation by reducing the price of imported goods. When the value of the US dollar increases, the price of imported products will also decrease. A related article predicted that the strengthening of the US dollar might help reduce the overall inflation of the United States by 0.2 to 0.3 percentage points.

Finally, the appreciation of the US dollar will affect the overseas operating income of some American enterprises, and then affect the company's share price. On the one hand, the strong US dollar makes the price of American exports higher, losing the price advantage; On the other hand, it will also reduce the sales of American enterprises. Credit Suisse (5.24, 0.01, 0.19%) estimates that every 8% - 10% appreciation of the U.S. dollar will lead to a 1% decline in corporate profits in the United States. In the recent US stock financial report, the influence of exchange rate has spread to many industries. For example, Johnson&Johnson (166.28, -1.32, -0.79%) expects that the appreciation of the US dollar will affect its sales this year by 4 billion dollars; Apple (154.48, 3.78, 2.51%) warned that exchange rate fluctuations would lead to a 6% decrease in revenue in this quarter.

Impact on emerging markets

The appreciation of the US dollar has raised concerns about the currency crisis in emerging markets. Externally, the appreciation of the US dollar has led to the pressure on foreign trade and foreign debt of emerging market countries, affected their income and costs, and increased the risk of debt default. Internally, the appreciation of the US dollar has made emerging economies face imported inflation and passive interest rate hikes, worsened economic fundamentals and intensified financial market volatility.

First, sovereign debt is under pressure. The aggressive interest rate increase by the Federal Reserve has pushed the US dollar up strongly, which has also put pressure on emerging market economies that must repay their dollar denominated debt. Sri Lanka, as the first country to declare bankruptcy due to "insolvency" in the interest rate increase storm, has USD debt of 51 billion, inflation of 39% and foreign exchange reserves of only 1.6 billion. In addition, against the background of the conflict between Russia and Ukraine and the rising US dollar, the possibility of Ukraine's sovereign debt default continues to increase. The conflict between Russia and Ukraine has led to the flight of investors, and Ukraine has been using foreign debt to fill its budget deficit. The appreciation of the US dollar also aggravates the burden of the country's foreign debt repayment and puts pressure on its sovereign debt.

Second, the outflow of funds was intensified. The direct reason for the appreciation of the US dollar is that the Federal Reserve started the interest rate raising cycle, and then the central banks of emerging market countries were forced to raise interest rates to ensure competitiveness and maintain currency stability. But passively starting the interest rate raising cycle will bring difficulties. On the one hand, in order to avoid the outflow of foreign investors' investment in the domestic economic field, the central banks of various countries have started the interest rate raising cycle. On the other hand, the rise in interest rates will increase the cost of domestic debt, leading to capital flight and inhibiting economic growth. By the end of July, overseas investors had withdrawn funds for five consecutive months, with a total outflow of more than $38 billion, the longest net outflow since 2005. According to the statistics of EPFR, an American research company, from January to July 2022, the capital inflow of developed countries' government bond funds was about 113 billion dollars. With the background of high inflation and tight currency, concerns about economic downturn have intensified, and more and more investors choose to invest their funds in more secure developed country bonds. In addition, capital flight will lead to pressure on emerging countries' economies, decline in fiscal revenues, and further aggravate debt risks.

Third, increase trade pressure. The strong US dollar may lead to increased trade pressure in emerging economies. At present, the currency of international trade payment and settlement is mainly US dollars. The development of many emerging economies depends to a large extent on global trade. The appreciation of the US dollar and the soaring price of resources denominated in US dollars have expanded the foreign exchange expenditure of countries relying on resource imports, thus expanding the trade deficit.

Impact on China

The appreciation of the US dollar has pushed the RMB to face greater pressure of devaluation. The differentiation of monetary policies between China and the United States, repeated outbreaks in some parts of the country, and the persistence of real estate disturbances have disturbed China's economic fundamentals and exacerbated short-term fluctuations of the RMB. On August 29, the onshore and offshore RMB hit a new two-year low against the US dollar. By the end of the day at 16:30, the onshore RMB had closed at 6.9210 against the U.S. dollar, touching 6.9229 as low as possible, 589 basis points lower than the previous trading day; The offshore RMB fell below 6.92 against the US dollar, reaching a minimum of 6.9315, and fell more than 300 points within the day. However, it is difficult for the RMB to depreciate for a long time. From the perspective of capital markets, by the end of 2021, the capital markets of China and the United States had reached US $30.7 trillion and US $40 trillion respectively, and China's overall size remained the second largest in the world. At present, the proportion of foreign capital participating in the mainland capital market is still small, but with the acceleration of the capital market opening process, the demand for RMB will increase, thereby supporting the exchange rate. From the perspective of trade, since August, the settlement and sale of foreign exchange by banks and foreign related receipts and payments in China have shown a double surplus, while the trade in goods has shown a high surplus. The actual use of foreign capital has maintained growth. Foreign investors have generally net purchased Chinese securities, which reflects the long-term investment value of RMB assets.

In terms of the bond market, in the first half of 2022, international funds will flow out significantly, with a cumulative net outflow of about 300 billion yuan from February to May, and the foreign investors' holdings of China's bonds will drop to 10.3%. However, the institutional opening of China's bond market has accelerated, facilitating the investment of foreign institutional investors. On May 27, 2022, the People's Bank of China, the CSRC and the SAFE issued a joint announcement to simplify the procedures for foreign investors to enter the market and expand the scope of investment to the exchange bond market. The announcement is conducive to promoting the diversification of investors, improving the liquidity and stability of China's bond market, expanding the inflow of capital projects, and better serving the real economy.

In the stock market, the appreciation of the US dollar paralleled the worries about the US economic recession. When the global economy fell into recession, the market risk appetite declined as a whole. The capital was more inclined to buy American bonds and other safe haven assets, and the A-share market also inevitably experienced capital outflows. However, the current A-share market is less affected, mainly due to the global policy tightening and economic downturn, while China still insists on stable growth, the domestic economy is expected to recover, while the foreign economy may continue to deteriorate, which is conducive to the inflow of funds from the north into A-share.

With the external interest rate increase cycle, the appreciation of the US dollar and the possible increase of the economic downturn in the euro area, China still faces the pressure of economic downturn and imported inflation. To be specific, the domestic economy is currently facing multiple pressures such as real estate risks and insufficient demand, but exports are still the driving force supporting China's economic fundamentals. As the largest trading partner of China, if the euro area economy falls into recession, it will inevitably increase the downward pressure on China's exports, which will lead to a domestic economic downturn. In addition, although the global interest rate hike is spreading, the effect of interest rate hike on inflation in various countries is not obvious, and the pressure of imported inflation still exists. On August 22, the Central Bank held a forum on the analysis of the monetary and credit situation of financial institutions and pointed out that we must consolidate the foundation for economic recovery and development with a sense of urgency. In the future, China's monetary policy should always focus on internal issues, give consideration to external balance, and highlight stable growth and employment.