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The reports of interest rate hikes by the Federal Reserve of the United States have spooked stock market investors across the globe. Many have speculated that such an action by the US Fed will encourage other nations to hold a hawkish stance to keep inflation in check. However, such a move might eventually result in a global stock market crash!

In this article, we shall go through the factors behind interest rate hikes and find out whether we really need to fear this decision.

The Story

Firstly, let us understand the basic macroeconomic concept of a business cycle. Businesses and the economy as a whole don’t move in a straight line. There are expansions and contractions in the economy (like ups and downs in a wave). As the economy expands, the long-term trend of these waves is always in a positive bias.

As a result of the economic contraction due to the COVID-19 pandemic, it was essential for governments and central banks of each country to expand their economy. So, they boosted their economy with incredible stimulus packages and low repo rates. Repo rate is the interest rate at which central banks (like the Reserve Bank of India and the Federal Reserve of the US) lend to commercial banks.

Businesses and individuals were able to avail packages and obtain loans easily. As the global economy started to revive with higher vaccination rates, the gross domestic product (GDP) of countries rebounded, and unemployment reduced drastically. Citizens started to spend more on products and services, as they were now fueled with more cash in their pockets. However, the suppliers could not keep up with the high demand! As the demand side skyrocketed, the supply side was broken. Supply chains were unable to satisfy the existing demand, which led to inflation. (Click here to read more about inflation).

In the graph shown above, you can see the impact of inflation in the US. It has hit a 40-year high. The inflation rate in December 2021 was 7% compared to the previous year. Let us look at the inflation rates of other countries.

We are now at the end of the expansion stage, and the economy is growing too fast. On the other hand, stock markets have rallied multifold and are at high valuations as inflation started to spread. If inflation is not controlled, the economy will quite literally collapse.

How do governments solve this issue? Here is where the monetary power of the central banks comes into the picture. The Federal Reserve can now increase the interest rates that were once decreased in the contraction period. Moving forward, it will be difficult for industries and individuals to avail loans. This move will lead to a decline in money flowing into the economy. Eventually, inflation will drop.

Effects on Stock Markets

Investors value stocks by the earnings they are likely to obtain in the future. For example, many have invested in highly valued startup companies like Nykaa, Paytm, and Zomato with the intention that they are disruptors in their respective fields. Moreover, these firms will be coming up with better sales and earnings in the future.

An increase in interest rates will lead to less liquidity among people. They will start to spend less and cut short their expenses, which ultimately affects the sales of companies. So the valuation of the companies will come under question, and investors will have a bearish sentiment on these stocks. Thus, any sectors that were valued with future earnings have a high risk when interest rates are hiked.

Conclusion

If not controlled, inflation can erode the wealth of a nation. Indeed, the action by the US Federal Reserve will create short-term money constraints in the economy. However, it will fuel greater expansion in the long term.

After the release of the minutes of the US Federal Reserve’s December policy meeting (click here to read about Fed minutes), the NASDAQ index of the US, in which tech stocks have high weightage, fell more than 7% to date. However, the Indian markets did not move down as much.

Moving forward, we will be able to see similar actions from the Reserve Bank of India (RBI) that may shake the Indian markets. Stocks of highly consumer-centric companies and tech firms could fall into a short-term bearish phase as their sales/earnings projections (to which their current valuation is tied up) would fall.

What are your views on the hike in interest rates? Do you think it will affect our markets severely? Let us know in the comments section of the marketfeed app.

1. Global Stock Rally Tempers After Vaccine Euphoria

Global equities are losing momentum after a six-day rally that sent stocks to all-time highs. Across markets, investors dumped expensive technology shares and snapped up small-caps and cyclical that are primed to benefit during an economic recovery from the pandemic. Futures on the Nasdaq 100 slumped 1.4%. In Europe, bank stocks were lifted by rising bond yields. Shares that have been hit hard by the economic toll of lockdowns like travel stocks and movie theatres soared. Stay-at-home companies plunged. Oil surged, while gold, the Japanese yen and the Swiss franc slumped. The dollar rose.

The S&P 500 went up 1.2% as of 4 p.m. New York time.

The Stoxx Europe 600 Index jumped 4%.

The MSCI Asia Pacific Index climbed 0.4%.

The MSCI Emerging Market Index gained 1.4%.

2. Lovin’ it: McDonald’s beats profit estimates, debuts McPlant line

The world’s biggest burger chain said it would launch a ‘McPlant’ line of plant-based foods, including meatless burgers and breakfast items, though it declined to say which suppliers it would use for plant burger, faux chicken and breakfast items. It previously tested a vegan PLT burger by Beyond Meat Inc in Canada. The world’s biggest burger chain beat revenue and profit estimates for the third quarter on Monday as customers in the United States ordered more hamburgers and fries in drive-through outlets and on delivery apps to avoid dining out during the pandemic.

3. Shell to Cut About 500 Singapore Refinery Jobs

Royal Dutch Shell plans to cut its oil-processing capacity in Singapore as part of efforts to curtail polluting emissions. The Anglo-Dutch company, which set out bolder climate goals in April, has said it sees oil-product demand falling as the world shifts to a cleaner energy mix. The oil major will halve processing capacity at its refinery on Singapore’s Pulau Bukom island. Downsizing the 500,000-barrel-a-day plant, Shell’s largest wholly-owned refinery, will mean reducing staff to about 800 by the end of 2023 from 1,300. Shell plans to eliminate all net emissions from its own operations and the bulk of greenhouse gases from fuel it sells to customers by 2050..

4. China Vaccine Trial Halted in Brazil After Serious Adverse Event

The final-stage trial of a Chinese frontrunner vaccine candidate has been halted in Brazil due to a serious adverse event, the first time that any of the Asian nation’s rapidly developed Covid-19 shots have met with such a setback. Testing of Sinovac Biotech vaccine, called Coronavac, has been halted in Brazil after an event that occurred on Oct. 29, said the Brazil Health Agency on Tuesday, without giving any further detail on what happened. The study is interrupted in accordance with regulations while the agency analyzes if the study should continue.

5. China Clampdown on Big Tech Puts More Billionaires on Notice

Xi Jinping’s Communist Party is stepping up efforts to rein in some of China’s most powerful companies, jolting investors and dealing a blow to the country’s richest entrepreneurs. Beijing on Tuesday unveiled regulations to root out monopolistic practices in the internet industry, seeking to curtail the growing influence of corporations like Alibaba Group and Tencent. The rules, which sent both stocks tumbling and sparked a wider selloff in Chinese equities, landed about a week after new restrictions on the finance sector that triggered the shock suspension of Ant Group Co.’s $35 billion IPO.

6. U.K. Unemployment Climbs Most Since 2009 as Job Cuts Soar

U.K. unemployment rose the most since the financial crisis over the summer, raising questions about how many job cuts could have been avoided had Chancellor of the Exchequer Rishi Sunak announced an extension to his furlough program sooner. The number of people looking for work surged by 243,000 in the three months through September, taking the jobless rate to 4.8%, the highest in four years, the Office for National Statistics said Tuesday. Job cuts, known as redundancies in the U.K., increased by a record 181,000 in the quarter to over 300,000.

7. Amazon Hit by EU Complaint, Faces New Probe Over Sales

Amazon.com Inc. became the European Union’s latest Big Tech target as regulators escalated a case into how it uses rivals’ sales data on its platform and added a new probe into whether it unfairly favours its own products. The European Commission said it suspects Amazon violated antitrust rules over its use of non-public business data from independent sellers on its marketplace that could benefit the company’s own retail arm. The EU regulator will also probe how Amazon chooses products for a prominent “buy box” and whether Amazon pushes retailers to use its own logistics and delivery services.

8. Australia considers opening borders to ‘low-risk’ Asian countries

Australia is considering opening its borders to some Asian countries, including parts of China, Prime Minister Scott Morrison said on Tuesday, as the government tries to revive an economy ravaged by COVID-19. Morrison ruled out entry from the United States or Europe but said Australia might allow entry to people travelling from low-risk countries such as Taiwan, Japan, Singapore as well as parts of China. China was the first country to which Australia closed its borders as the COVID-19 outbreak gathered pace in Wuhan in January. It later expanded the ban to all countries and imposed a cap on the number of non-citizens and permanent residents allowed to return home because of concerns about whether its hotel quarantine system could cope. Last month, it allowed New Zealand residents to enter the country.

9. US sanctions more officials over China’s crackdown in Hong Kong

The U.S. places sanctions on four more Hong Kong officials over a China-imposed national security law. The United States has slapped sanctions on four more officials in the mainland and Hong Kong, accusing them of threatening the peace and security of the semi-autonomous city over their role in enacting the national security law imposed by Beijing at the end of June. The US Department of State identified the four as Deng Zhonghua, deputy director of the Hong Kong and Macau Affairs Office; Edwina Lau, deputy commissioner of police in Hong Kong, and Li Jiangzhou and Li Kwai-wah, two officials at the newly established national security office in Hong Kong.

10. US aviation regulator in final stages of approving Boeing 737 MAX

Federal Aviation Administration tells Reuters it sees its review of the grounded jet being completed in the “coming days”. The United States Federal Aviation Administration (FAA) is in the final stages of reviewing proposed changes to Boeing’s grounded 737 MAX jet and expects to complete the process in the “coming days,” the agency’s chief told the Reuters news agency.

Three sources briefed on the matter told Reuters the FAA is set to lift its grounding order on the plane as early as November 18. FAA Administrator Steve Dickson told Reuters in a statement that he expects “this process will be finished in the coming days, once the agency is satisfied that Boeing has addressed” safety issues involved in two fatal crashes. The crashes, one in Indonesia in October 2018 and the other in Ethiopia in March 2019, killed a total of 346 people. The lifting of the grounding order would be a vital step in a still-arduous path to recovery for Boeing, plunged into its worst-ever crisis by the crashes and the worldwide mothballing of its best-selling plane in March 2019.