The rate hike is confirmed! The Federal Reserve's tightening cycle may restart, and global markets could face a chain reaction.

According to Zhihui Finance APP, the Federal Reserve is tightening monetary policy, and its impact is likely to extend far beyond the United States. On Wednesday, the Federal Reserve announced an increase in the federal funds rate target range by 25 basis points to 3.75%—4%. This is the first rate hike by the Fed since July 2023. What is even more noteworthy is that, according to the latest dot plot observing the Fed’s future policy operations, 16 out of 18 officials who submitted rate forecasts expect at least one more hike this year.

Fed Chairman Walsh stated that the U.S. economy is showing signs of strengthening, but the underlying trend of inflation has not visibly improved, and the current policy focus is on bringing down inflation. Regarding this rate hike, Walsh described it as “reducing some policy easing.” He said that overall financial conditions currently are still far from being described as restrictive, and the Federal Open Market Committee (FOMC) members generally agree with this assessment.

Historically, when the Federal Reserve begins raising rates, it is rarely a one-off adjustment. Before this meeting, the market was focused on when and by how much the rate would be raised. Now that the rate hike is a reality, the market worries about whether this signals the start of a new rate hike cycle and when the next move will be. Traders currently expect three more rate hikes by the Fed by mid-next year, one more than expected before the decision. Interest rate swaps indicate the next hike could come as early as next month.

This week’s 25 basis point rate hike may not be an isolated policy move. Upcoming inflation, employment, and energy price data will be key factors in determining whether the Fed will continue tightening later this year.

Experts note that for global markets, a new round of tightening in the U.S. could mean a stronger dollar, greater pressure on other currencies, and reduced room for other central banks to ease monetary policy. Higher U.S. rates could also keep global bond yields high and put pressure on stock valuations and economic growth.

Upward Pressure on the Dollar, Downward Pressure on Other Currencies

One of the most direct channels through which Fed tightening transmits globally is the U.S. dollar. Higher U.S. rates support the dollar and put pressure on other currencies.

Moody’s Analytics Chief Economist Mark Zandi said that this Fed rate hike and indications of more to come are putting some upward pressure on the dollar, while putting downward pressure on other currencies, especially economies whose currencies or monetary policy are closely tied to U.S. interest rates. BlackRock’s Head of Asia-Pacific Global Fixed Income Navin Saigal also commented that the market’s hawkish interpretation of the Fed meeting “may bring some short-term pressure to Asian currencies and bond markets.”

Japan is a focal point for markets. Mark Zandi further explained that a weaker yen could further reinforce the Bank of Japan’s case for continued tightening, “This really puts pressure on Japan, prompting them to continue following and raise rates.”

Currency depreciation could also make it more complicated for central banks to fight inflation, because weaker currencies push up the local currency cost of imported goods. With this happening, oil prices have already surged due to Middle East conflicts, putting some economies at risk of rising energy costs, weaker currencies, and high interest rates occurring simultaneously.

Other Central Banks’ Monetary Policies May Be Affected

As the Federal Reserve shifts policy, some major developed market central banks are also tightening. The European Central Bank raised rates by 25 basis points last week, and JPMorgan Asset Management expects the Bank of Japan to raise rates by 25 basis points this week. JPMorgan Asset Management Asia-Pacific Chief Market Strategist Tai Hui said, “Developed market central banks are tightening monetary policy in sync to address inflation concerns.” Higher U.S. Treasury yields due to higher rates also increase the likelihood of capital flowing into the U.S. from other markets, putting pressure on other central banks to respond.

However, the Fed’s actions do not necessarily mean the world will enter a synchronized rate hike cycle. Inflation conditions across Asian economies are highly divergent. China and Thailand still face deflationary pressure, while inflation in Australia and Japan remains above central bank targets. BlackRock notes that at the same time, India’s inflation is near the midpoint of the Reserve Bank of India’s target range. This means that even if a stronger dollar reduces policymakers’ room to ease policy, domestic economic conditions in each economy could ultimately overwhelm the mechanical pressure to follow the Fed.

High Rates May Suppress Equity Markets and Economic Growth

For financial markets, prolonged high interest rates mean that stocks and other risk assets face a higher bar. Rising government bond yields make fixed income assets more attractive relative to stocks, while raising corporate financing costs and reducing investors’ present valuations of future profits.

Charles Schwab Chief Investment Strategist Liz Ann Sonders said that the level of yields may be less important than the speed at which yields rise and whether the process is orderly. She remarked that the 10-year U.S. Treasury yield moving towards 5% is generally reasonable given factors such as inflation, Fed policy expectations, and strong nominal economic growth.

Liz Ann Sonders said, “I believe that if yields start to move in a disorderly manner, the stock market will face greater absorption pressures. But as long as the process remains orderly, both the economy and markets can to some extent withstand this change.”

Such pressure is also unlikely to be distributed evenly. Liz Ann Sonders said that higher interest rates have already begun to impact more economically sensitive areas of the market, while robust earnings could complicate the inflation outlook by supporting employment and hiring.

JPMorgan’s Tai Hui noted that if the Fed’s hawkish stance lasts through 2027, investors may need to reassess valuations, especially for rate-sensitive technology stocks.

For global markets, higher U.S. rates are just one aspect. A resilient U.S. economy gives the Fed room to tighten while also potentially supporting external demand and corporate activity in other regions. BlackRock’s Navin Saigal said that even though higher rates may cause short-term stress, strong U.S. economic growth should continue to drive global economic activity, trade flows, and corporate fundamentals in Asia.