p align = “center” / core ideas /
Since 2022, the expectation of the Fed’s interest rate hike has been strengthened. This week’s FOMC meeting will usher in the first interest rate hike. As the “master valve” of the global capital market, what impact will the Fed’s interest rate increase and reduction have on the global economy and market? Through which channels will it act on a shares?
for the US economy, raising interest rates will inhibit the recovery, but will not cause serious impact
The interest rate hike will generally be implemented under the background of good economic recovery or even overheating. Although it will inhibit the momentum of economic growth, it will take a long time window from interest rate hike to economic recession. If the Federal Reserve officially opens the interest rate increase agenda in March, it is unlikely that the US economy will be seriously impacted in 2022.
interest rate increase + table reduction will continue to push up the interest rate of long-end and short-end US bonds
The short-term interest rate is highly consistent with the trend of the federal funds rate. The Fed’s interest rate increase will first directly increase the short-term capital cost. The shrinking table (expected) will limit the convergence speed of term interest rate spread, so as to support the rise of long-term US bonds. When the interest rate increase and table reduction policies are implemented, the long-term interest rate will probably reach a phased high.
the first interest rate hike will impact US stocks in the short term. US stocks are likely to perform strongly one year after the interest rate hike historical experience shows that US stocks will be negatively impacted one month after the interest rate hike, and US stocks are likely to perform well in the first year after each round of the first interest rate hike. The reason behind this may be that economic growth supports the growth of corporate profits and the rise of the stock market. The impact of the contraction on US stocks mainly depends on whether the Fed can effectively guide market expectations.
Fed monetary tightening will affect A-Shares through three channels: first, exchange rate transmission channel : monetary tightening will boost the US dollar index and increase the pressure of RMB devaluation in the short term. On the one hand, exchange gains and losses will directly affect the current profits of listed companies, on the other hand, it will improve the overseas competitiveness of export-oriented enterprises, Reduce the profit margin of imported enterprises No. II. Interest rate transmission channel : the tightening of money by the Federal Reserve will increase the return on US dollar assets, while China’s long-term and short-term interest rates are highly correlated with the US federal fund interest rate. The rise of China’s bond interest rate will suppress the valuation of A-share growth sector, that is, “structural impact” third, sentiment transmission channel : the tightening of the Federal Reserve has led to increased volatility in overseas markets, increased risk aversion, and the confidence of A-share investors will also be affected in the short term.
three possible situations of the impact of the Fed’s monetary tightening on A-Shares in the future
scenario 1: Fed tightening + foreign capital return + but the RMB is stable relative to the US dollar, which will block the “exchange rate” channel. The impact on A-Shares is short-term (emotional transmission) + structural (growth shares are suppressed) scenario 2: US Federal Reserve raises interest rates + interest rate spread narrows + China remains loose, which will block the “interest rate” channel. “Internal loose” has more pricing power over A-Shares than “external tight”, and there will be no obvious decline in the Chinese market. Under the “external tightening and internal loosening”, the winning rate of consumption and finance is high, blue chip stocks and low price to book ratio stocks are more likely to obtain excess returns, and social services, banking, medicine and biology and other industries are relatively dominant scenario 3: China was forced to adopt follow-up interest rate hike, resulting in overall and continuous pressure on a shares, but the probability of this situation is small.
summary
In the context of China’s outstanding demand for “steady growth” and the continuous warming of external uncertainty, we believe that in the short term after the Fed’s interest rate hike, scenario 1 will dominate , that is, in the expected chaotic stage, risk aversion will strengthen and structurally bearish growth stocks however, as the trend of interest rate increase and table reduction policies becomes clearer, situation 2 will dominate , that is, the impact of external tightening on A-Shares is limited, and the impact of “internal loosening” is greater than that of “external tightening”.
risk tips : 1. Geopolitical uncertainty; 2. The Fed’s monetary policy exceeded expectationsP align = “center” / report body /
how does interest rate increase + table reduction affect a shares—— Three paths and three situations
Since 2022, with regard to the Fed’s expectation of raising interest rates, Powell said at the semi annual hearing of Congress last week (March 3) that the next interest rate meeting in March will raise interest rates by 25bp. As the “general valve” of the global capital market, what impact will the Fed’s interest rate increase and contraction have on the global economy and market? Through which channels will it act on a shares? This paper will focus on the three impact paths and three possible situations of the Fed’s interest rate hike.
I. impact of interest rate hike on the US economy: restrain recovery but not cause serious impact
Since 1955, the United States has experienced a total of 13 complete interest rate increase cycles, with an average duration of about two years (23 months) and an average rate increase of 4.47 percentage points.
generally speaking, the interest rate hike will be implemented under the background of good economic recovery or even overheating. Although it will restrain the momentum of economic growth, it will take a long time window from interest rate hike to economic recession if calculated from the day when the interest rate increase is announced, the economic recession stage in history will appear after 42 months on average, about 3 to 3.5 years. The shortest one was in 1980, which was only 11 months from the first interest rate hike to the economic recession in 1981; The longest one was in 1983, with an interval of 86 months from the first interest rate hike to the economic recession in 1990.
Therefore, it takes a long time window for the fed to raise interest rates to have a negative impact on economic growth. At present, even if the Federal Reserve officially opens the interest rate increase agenda in March, it is unlikely to have a serious impact on the US economy in 2022.
II. For US bond interest rate: interest rate increase + table reduction will continue to push up the long-term and short-term US bond interest rates
short-term interest rate is highly consistent with the trend of federal funds rate. The Fed’s interest rate increase will directly increase the short-term capital cost . Due to the current flood of market liquidity, the excess deposit reserve and overnight reverse repurchase alone are as high as $5.5 trillion. It is difficult for the Federal Reserve to have an impact on the “floor interest rate corridor” mechanism at the initial stage of interest rate increase and table contraction. Therefore, under the current “floor interest rate corridor mechanism”, the Fed’s interest rate hike will drive the upward trend of short-end US bond yields. In the last three interest rate hike cycles, the yield of one-year US bonds rose by 1.36%, 3.16% and 1.95% respectively.
shrinkage table (expected) will limit the convergence rate of term interest spread and support the rise of long-term US bonds. Matching with the interest rate increase, it will limit the convergence rate of term interest spread and support the long-term yield. After the interest rate increase is implemented, the long-term interest rate may reach a phased high . Based on the above analysis, it can be seen that the interest rate increase (expected) will directly lead to the rise of short-term interest rate, but will also narrow the term spread (10y-2y). Therefore, the direction of long-term US bond yield at the initial stage of interest rate increase is not clear. However, the reduction of the table will limit and slow down the convergence rate of term interest spread. After superimposed with the rise of short-term interest rate caused by interest rate increase, it will support the rise of long-term US bond interest rate. Therefore, after the interest rate increase is implemented, the interest rate curve tends to flatten, and even the periodic high of the long-end interest rate . In the last three interest rate increase cycles, the yield of 10-year US bonds rose by 0.62%, 0.60% and 0.55% respectively.
the medium-term trend of long-term interest rate still depends on the momentum of economic growth, and the increase of interest rate and the contraction of table will inhibit the economic recovery to a certain extent . From the perspective of the latest round of interest rate increase cycle and the process of table contraction, in the process of the first four interest rate increases, the fluctuation center of the 10-year US bond yield basically remained stable until the US economy officially opened the table contraction to the Federal Reserve. Under the joint action of the expectation of good economic growth and the contraction of liquidity, the 10-year US bond yield continued to rise. However, with the weakening of medium – and long-term economic growth expectations in the United States, even in the stage of the Fed’s table contraction, it failed to change the downward trend of 10-year US bond yields.
III. for the global stock market: the short-term impact on the global stock market after the interest rate hike is obvious, and the reduction of the table has little impact
after the interest rate increase, the global stock market will be significantly impacted in the short term, and the table reduction will hardly have a negative impact . First of all, we reviewed the performance of global stock indexes in the last three US interest rate hike cycles. Over the past 20 years, the Federal Reserve has experienced three interest rate hike cycles. The first rate hike was from June 1999 to May 2000. The background of interest rate increase was mainly to curb the Internet bubble, and the benchmark interest rate was raised from 4.75% to 6.5%. The second increase rate period was from June 2004 to June 2006, the benchmark interest rate rose from 1% to 5.25%, mainly for the then real estate bubble. The third interest rate increase cycle is from December 2015 to December 2018, and the benchmark interest rate is raised from 0.25% to 2.5%. The background of interest rate increase is mainly to deal with the normalization of monetary policy after the financial crisis. Among them, the third interest rate increase cycle also implemented the active table reduction.
before and after the contraction, the rise and fall of a shares, Hong Kong stocks and US stocks were basically positive . After the contraction of the balance sheet began in October 2017, although US bond interest rates rose in the first three quarters of 2018, US stocks also rose. This high probability is because the expected management of tightening policies was in place at that time, and the momentum of economic growth was relatively strong. The upward performance of the company can resist the downward pressure of valuation. Therefore, in this part, we mainly discuss the negative impact of interest rate hike on US stocks.
31. Short term perspective: little impact before tightening, obvious impact later
before the interest rate increase, the global market was not affected much . In the last three rounds of interest rate hikes, in the first month of the Fed’s first interest rate hike, 11 major stock indexes in the world rose or fell. In the three rounds of interest rate hikes, each stock index rose by 12.97%, 1.24% and 0.84% respectively however, the global stock market was significantly impacted in the first month after the interest rate hike . In the last three rounds of interest rate hikes, one month after the first interest rate hike by the Federal Reserve, 11 major stock indexes in the world fell sharply, with an average decline of 4.6%, 11.34% and 1.88% respectively.
in the short term, the trend of U.S. stocks in the month before the current interest rate increase cycle will still be dominated by external uncertainties such as the Russian Ukrainian war and rising crude oil prices, and the impact of interest rate increase is relatively insignificant . The escalation of the conflict between Russia and Ukraine triggered another surge in commodity prices, exacerbated people’s concerns about “stagflation”, sold off risky assets, and all three major indexes of US stocks fell last week. Among them, the Dow fell 1.32% for the fourth consecutive week, the NASDAQ fell 2.78% and the S & P 500 index fell 1.27%. According to the latest data on March 6, the price earnings ratio of US stock NASDAQ is only 31.07 times, which is at the historical 38.89% quantile, which is lower than the quantile level on the first day of the previous interest rate increase cycle (December 15, 2015), and the valuation level is already low. Therefore, assuming that the Fed raises interest rates in mid March, the trend of US stocks in the short term after the interest rate hike will still be dominated by geopolitics, crude oil prices and other factors, and the impact of the interest rate hike is relatively insignificant.
32. Medium and long term perspective: the impact of profit growth is greater than the valuation, and the probability of US stocks is better during the tightening cycle
taking history as a mirror, one year after the first interest rate hike, US stocks performed well. The reason behind this is that economic growth often supports the growth of corporate profits and the rise of stock market . Since the 1950s, most US stocks have achieved positive returns, with an average annual increase of 9%. However, in the interest rate increase cycle of the Federal Reserve, the valuation of US stocks basically decreased. The logic behind this is that in the interest rate increase cycle, the growth rate of corporate profits exceeds the decline rate of valuation, that is, economic growth supports the growth of corporate profits and the rise of stock market.
The impact of reduction on US stocks mainly depends on whether the Federal Reserve effectively guides market expectations . There are two rounds of shrinking in the history of the United States: the first paragraph occurred in the early twenty-first Century, and the US Federal Reserve’s ultra expected withdrawal liquidity not only punctured the “Internet bubble”, but also led to a sharp fall in US stocks. The second paragraph occurred in 2017. The Federal Reserve first released the signal of scale reduction in March, then proposed the “quantitative scale reduction” in May and disclosed the “quantitative scale reduction” scheme in June; July hinted that the contraction would come soon. Finally, the Federal Reserve announced at the FOMC meeting in September that it would start to shrink the table from October.
The contraction table has almost no negative impact on the overall stock market. In the future table reduction process, considering that the Federal Reserve has accumulated some experience and lessons in maintaining communication with the market, it is expected to have little impact on US stocks.
IV. three paths of Fed monetary tightening affecting A-Shares
41. Exchange rate transmission channel: monetary tightening → US dollar appreciation → RMB depreciation → affecting the operation and profits of listed companies
the Fed’s interest rate hike and table contraction will boost the US dollar index and increase the pressure on RMB devaluation in the short term . When the Fed hints or formally discusses raising interest rates and shrinking the table, the US dollar index is likely to rebound; After the announcement of interest rate increase and the implementation of table contraction, the US dollar index is prone to periodic correction.
As can be seen from the trend of the US federal funds rate and the exchange rate of the US dollar against the RMB, during the interest rate hike by the Federal Reserve, the exchange rate of the US dollar against the RMB as a whole showed a volatile upward trend . For example, at the beginning of the last round of monetary tightening cycle of the Federal Reserve, the RMB began to depreciate. Until the end of 2016, the bilateral exchange rate rose from 6.2 in July 2015 to 6.92 in December 2016 Since 2017 (when the scale was reduced in October), although the Federal Reserve is still in the tightening range, the favorable stimulus of RMB’s entry into the SDR basket and a series of policies adopted by China to prevent the adverse effects of continuous RMB depreciation (such as the introduction of “countercyclical factor”) have reversed the pressure of RMB depreciation caused by the Federal Reserve’s interest rate increase.
RMB devaluation will have an impact on the operation and profits of A-share listed companies, and the direction varies from individual to individual . RMB devaluation will have an impact on the performance of listed companies from two dimensions. On the one hand, exchange gains and losses will directly affect the current profits of listed companies. For example, in the export activities of enterprises, the depreciation of RMB will lead to the exchange loss of accounts receivable, thus reducing the profits of enterprises. On the other hand, the devaluation of RMB will help improve the overseas competitiveness of export enterprises and reduce the profit space of import enterprises. To sum up, the impact of RMB devaluation on A-share listed companies varies from individual to individual.
42. Interest rate transmission channel: monetary tightening → rising US bond interest rate → narrowing China US interest rate spread → rising Chinese interest rate → capital flowing back to the United States → pressure on growth stocks
the tightening of monetary policy by the Federal Reserve will increase the yield of US dollar assets and trigger the return of capital from other countries to the United States . With the rising federal funds rate in the United States, the attractiveness of the dollar has increased. Then other countries face a dilemma: first, follow or even advance interest rate hikes to ensure the relative stability of local currency capital return and dollar asset return, but this will inhibit their economic recovery; Second, if the goal of economic recovery is not to raise interest rates, the interest rate difference between the return on domestic assets and the return on US dollar assets will expand, facing the risk of devaluation of local currency and continuous outflow of funds. This contradiction also exists in China.
US federal funds rate has a high correlation with China’s long-term and short-term interest rates . In order to prevent the excessive outflow of international capital, the long-term interest rate difference between China and the United States must be kept within a certain “safety cushion”. Therefore, the Shibor interest rate at the short end will increase with the rise of the US federal funds rate in most cases, showing a trend of changing in the same direction. For example, during the Federal Reserve’s interest rate hike and table contraction in 2016 and 2017, Shibor interest rate (six months) showed a volatile upward trend as a whole.
China’s bond interest rate rose, suppressing the valuation of A-share growth sector. As the bond yield is the pricing anchor in the DCF model, when the yield rises, the overvalued stocks will be revalued, especially the growth stocks with discounted future cash flow as the main valuation logic, and their valuation and stock price will be under pressure.
4.3. Sentiment transmission channels: monetary tightening → increased volatility in overseas markets → increased risk aversion → decreased confidence of A-share investors
the tightening of the Federal Reserve led to increased volatility in overseas markets, increased risk aversion and affected the confidence of A-share investors . Whether it is the expected stage or the landing stage of the Fed’s interest rate increase and contraction table, the uncertainty of the policy may trigger the risk aversion of the market at any time. From this round of Fed monetary policy cycle, we can see that the global market is highly sensitive to the shift of Fed policy. At the same time, the linkage between A-Shares and overseas markets is also increasingly strengthened. If the Fed tightens, it will lead to the tightening of global liquidity. On the one hand, it will intensify the vulnerability of emerging markets and increase the uncertainty of global markets; On the other hand, it will also suppress the performance of US stocks in the short term. The increased volatility of US stocks and emerging markets will lead to the rise of global risk aversion, which will affect the investment confidence of foreign and Chinese investors in a shares.
interest rate hike led to the decline of U.S. and Hong Kong stocks, which will probably drag down the performance of A-Shares in the short term, but the shrinkage has no significant impact . As shown in the statistical results in Figure 5, the fluctuation of overseas interest rate increase does have a short-term negative impact on us and Hong Kong stocks, and the window period is about one month after the interest rate increase; The impact of the Fed’s table contraction on A-Shares is not significant. Historical experience shows that when the peripheral market performs poorly, A-Shares usually follow the decline, that is, they are vulnerable to overseas bearish sentiment.
v. three situations in which the Fed’s monetary tightening affects A-Shares
Among the three influence channels discussed above, of which the first (exchange rate transmission channel) has a continuous + overall impact on A-Shares the second (interest rate transmission channel) has a continuous + structural impact on a shares, which is mainly bad for growth stocks the third (emotional transmission channel) the impact on A-Shares is short-term volatility.
Among them, the impact of the third emotional transmission channel is inevitable, but it is also short-term. It will not suppress the performance of A-Shares for a long time, which is not enough to be afraid. However, the impact of the first and second influence channels on A-Shares is continuous, and there are certain preconditions for their occurrence. Therefore, we envisage three possible situations in the process of fed interest rate increase + table reduction in the future, and analyze the possible pressure on the corresponding A shares.
51. Scenario 1: Fed tightening + foreign capital repatriation + but the value of RMB relative to the US dollar is stable → short term + structural impact
generally speaking, the tightening of the Federal Reserve will promote the return of the US dollar, and the exchange rate of the US dollar against the RMB is highly consistent with the flow of foreign capital . With the continuous advancement of the internationalization of a shares, foreign capital has become one of the most important incremental funds in the A-share market, which has a profound impact on the pricing mechanism of a shares. Especially in recent years, in the range of RMB appreciation, the inflow of funds going north has accelerated. In the strong range of the US dollar, the northward inflow fluctuates violently, which has a negative impact on the liquidity of China’s A-share market.
however, the return of foreign capital caused by interest rate increase and table contraction does not necessarily lead to the appreciation of the US dollar and the depreciation of the RMB .
Judging from the performance of the US dollar index in previous Fed tightening cycles, the US dollar may appreciate or depreciate. The logic of appreciation is that the US interest rate hike is often implemented when the economy is improving or even overheating, and a country’s currency will price its own economic growth prospects to a certain extent. In the interest rate increase cycle, if the US dollar depreciates compared with the RMB, the probability is mainly affected by two factors: first, China’s large export surplus and high demand for foreign exchange settlement support the RMB; Second, the recovery of Europe and the United States or the dislocation of monetary policy, the relatively strong economy of the eurozone, or the tightening of the monetary policy of the European Central Bank may suppress the US dollar.
Therefore, if China’s exports remain strong or the European monetary policy tightens, it may support the value of the RMB during the tightening period of the Federal Reserve, thus cutting off the “exchange rate” transmission channel through which the US interest rate increase affects the operation and profits of A-share listed companies (US interest rate increase – US dollar appreciation – RMB depreciation – affects the operation and profits of listed companies). In this case, the impact of US interest rate hike on A-Shares is only structural (interest rate channel) and short-term (emotional channel).
52. Scenario 2: the Fed raises interest rates + the interest rate spread narrows + China remains loose → “internal loosening” has a greater impact than “external tightening”
in 2022, the macro policies of China and the United States may be divided, showing a situation of “internal loosening and external tightening” . In 2022, the US fiscal rate will probably decline, and the monetary policy will face the pressure of “raising interest rates + shrinking the table”. At the same time, the UK has recently raised interest rates twice in a row, and the attitude of the eurozone towards monetary policy has also “changed from dove to Eagle”. Supported by the goal of “stable growth”, China’s fiscal and monetary policies are likely to remain loose in 2022. The macro policy environment of China’s capital market will be better than that of overseas countries, showing a situation of “internal loosening and external tightening” as a whole.
Based on the characteristics of “dislocation” of monetary policies in the United States and China, we resumed the performance of A-Shares under the background of “external tightening and internal loosening” of nine long-term interest rates in history.
historical experience shows that “inner loose” has more pricing power over “outer tight” A shares . The results show that in similar historical stages, consumption and finance have a high winning rate, while the growth, cycle and stability sectors are relatively weak, but the latter does not show obvious downward characteristics . Blue chip stocks and low price to book stocks can obtain excess return ; Low profit stocks and high P / E sectors with poor profit expectations were slightly frustrated. In terms of industry, social services and transportation industry have a high winning rate, while social services, banking, medicine and biology, transportation and other industries have a relatively dominant increase. There is no obvious downward characteristic in the market. “Inner loose” has more pricing power on A-Shares than “outer tight”.
Overall, in case 2, due to China’s adherence to loose monetary policy, the link of “China’s interest rate rise” in (US interest rate rise – US bond interest rate rise – narrowing of China US interest rate spread – China’s interest rate rise – pressure on growth stocks) was cut off, The impact of Fed tightening on A-Shares is mainly reflected in short-term sentiment transmission . That is, in the expected confusion stage before the future interest rate increase or table reduction, the sharp rise of US debt may infect the valuation of A-share growth stocks through short-term emotions. However, with the gradual clarity of the trend of interest rate increase and table reduction policies, its medium-term impact on A-shares is limited.
53. Scenario 3: monetary tightening + serious devaluation of RMB + tightening of China’s monetary policy → overall pressure on A-Shares
The third and worst case scenario: on the one hand , in the process of interest rate increase + table contraction by the Federal Reserve, if China’s exports tend to be weak and the monetary policy of the European central bank turns dove again, the Russian Ukrainian war continues to warm up and pull up the US dollar index, the three will jointly stimulate the rise of the US dollar and the relative depreciation of the RMB, Through the “exchange rate” channel, A-Shares are fully suppressed on the other hand , in order to curb the devaluation of the currency, China had to maintain the interest rate difference between China and the United States at a certain level through a tight monetary policy. The rise of China’s interest rate will further depress the valuation level of the growth sector and have a structural negative impact on a shares.
however, we believe that this situation is unlikely to occur for three reasons . First, China’s economy is facing downward pressure, with strong demand for steady growth, and the tightening monetary policy is inconsistent with the current policy setting; Second, the US market has fully expected the fed to raise interest rates in March and shrink its table in June 2022. Assuming that the US bond interest rate continues to rise to 2.2% and the Treasury bond interest rate drops to 2.5%, the interest rate gap between China and the United States is still 30 basis points, and there is still room for China to cut interest rates; Third, in history, there have been cases of upside down interest rate spreads between China and the United States in 2008 and 2018. To sum up, China’s monetary policy will still adhere to the purpose of “focusing on me” and the core goal of “stable growth”, and blindly follow the overseas interest rate increase, which makes it unlikely that A-Shares will be under overall pressure (case 3).
VI. summary
Under the background of the confirmation of the Fed’s interest rate hike policy in March and the continuous strengthening of the expectation of table contraction in June, we believe that there are three channels for the impact of the Fed’s tightening on a shares: exchange rate channel, interest rate channel and emotional channel. The final impact of the three channels on A-Shares is: comprehensive + continuous, structural + continuous and short-term fluctuation.
Subsequently, according to the trend of economic and monetary policies at home and abroad, we set three possible situations in the future, namely:
First, the Fed tightened, but the value of RMB against the US dollar remained relatively stable, which would block the “exchange rate” channel. The impact on A-Shares was short-term + structural;
Second, the US Federal Reserve has tightened and the interest rate gap between China and the United States has narrowed, but China remains loose, which will block the channel of “interest rate”, and ultimately the impact of “internal loosening” will be greater than that of “external tightening”;
Third, China’s follow-up interest rate hike has led to overall and continuous pressure on a shares, but we believe that the probability of such monetary policy is small.
In the context of China’s prominent demand for “stable growth” and the continuous warming of external uncertainty, we believe that in the short term after the Fed’s interest rate hike, scenario 1 will dominate, that is, in the expected chaotic stage, risk aversion will strengthen and structurally bearish growth stocks ; However, as the trend of interest rate increase and table contraction policy becomes clearer, situation 2 will dominate, that is, the impact of external tightening on A-Shares is limited, and the impact of “internal loosening” is greater than that of “external tightening”
