How should Taiwan's economy respond to the wave of US dollar interest rate hikes?

U.S. Rate Hike Progress Review and 2024 Outlook

Since March 2022, the Federal Reserve has initiated the most aggressive rate hike cycle in nearly a decade. By the end of 2023, it had raised interest rates 20 times (500 basis points), with the benchmark rate rising from near zero to a range of 5.00%-5.25%.

This rate hike cycle is characterized as “fast and fierce”—in ten consecutive policy meetings, the Fed chose to raise rates each time, with June, July, September, and November 2022 each increasing by 75 bps for four consecutive months, an extremely rare occurrence in history. The fundamental driver behind this was the predicament of inflation soaring to a 40-year high in June 2022.

Entering 2024, market doubts remain whether the Fed will further raise rates. Although inflation shows a downward trend, it still lags behind the 2% policy target. Meanwhile, the banking crisis that erupted in 2023 has also raised concerns about financial stability. According to market expectations, the Fed may adopt a moderate rate cut path in 2024, but the possibility of further rate hikes still exists.

How U.S. Rate Hikes Are Reshaping Global Asset Prices

Chain Reaction of U.S. Dollar Appreciation

Rising interest rates typically push up the U.S. dollar exchange rate. The logic is simple—higher interest rates increase the yield on U.S. bank deposits, prompting global investors to flock to buy dollars for deposits, leading to a natural appreciation of the dollar due to increased demand. The 8.5% rise in the dollar index in 2022 is a clear example.

Dual Pressure on the Stock Market

Rate hikes exert downward pressure on stock markets through two mechanisms: first, rising interest rates directly erode company valuations (asset prices are inversely related to interest rates); second, increased corporate financing costs weaken profitability. This explains why global stock markets plunged in 2022, with the S&P 500 down 17% and the Nasdaq dropping 30%.

However, in 2023, stock markets rebounded, mainly because investors tend to anticipate policy shifts near the end of rate hike cycles. This reminds us that many factors influence the stock market, and it cannot be solely attributed to one variable.

Gold and Expectation Play

Gold prices tend to have an inverse relationship with rate hike expectations. When the market anticipates stronger rate hikes, gold prices fall; if expectations shift toward rate cuts or easing, gold prices rise. In 2022, gold continued to decline in the first half of the year but reversed and rose after year-end, reflecting these changing expectations.

Hidden Risks in the Bond Market

Rate hikes cause bond prices to fall (interest rates and bond prices are inversely related), harming financial institutions holding large amounts of bonds. The 2023 U.S. banking crisis partly stems from this—banks faced bond losses and were forced to sell large volumes of bonds for cash, creating a vicious cycle.

Practical Challenges Facing Taiwan’s Economy

The Snowball Effect of TWD Depreciation

U.S. dollar appreciation inevitably leads to TWD depreciation—TWD weakens against the dollar, meaning fewer dollars can be bought with the same amount of TWD. This directly triggers inflationary pressures. In 2022, Taiwan’s food CPI rose 6%, with egg prices soaring 26%, mainly due to rising import feed costs.

Taiwan’s reliance on imported agricultural products is astonishing—22.8% of imported agricultural products in 2022 came from the U.S. International commodity prices are dollar-denominated, so dollar appreciation directly pushes up import prices.

Although the Central Bank has also started raising interest rates (a total of 75 bps over five hikes since 2022), the effort is far less aggressive than the Fed’s, making it impossible to halt the overall downward trend of the TWD.

Hidden Risks of Capital Outflows

The most severe consequence of currency depreciation is capital outflow. Imagine an overseas investor exchanging $100,000 for NT$2.7 million to buy Taiwanese stocks, earning NT$300,000 in a year—that should be a good return. But if the TWD depreciates 11% in that year, the NT$3 million becomes only about $97,000, resulting in a loss. Facing this dilemma, rational investors tend to sell stocks and convert to dollars to hedge risks. When large amounts of capital flee simultaneously, the stock market inevitably becomes volatile.

According to Taiwan Stock Exchange data, in 2022, Taiwan’s capital outflow from the stock market reached $41.6 billion, the highest in Asia, accounting for over 70% of the region’s total outflows. The Taiwan Weighted Index fell 21% for the year, ranking sixth from the bottom globally.

Asset Allocation Recommendations in the Rate Hike Era

Identify Beneficiaries of Rate Hikes

Not all stocks suffer during rate hike periods. Financial stocks (especially banks) benefit from widened deposit-loan interest spreads. For example, Taiwan’s Mega Bank’s interest income reached NT$33.3 billion in 2022, up 38% year-over-year, with its stock price rising 20% within a year. Similar financial stocks can partially offset the overall negative impact of rising rates.

Construct Hedging Strategies

In addition to shifting to high-dividend stocks, investors can consider shorting related indices to hedge risks. Since Taiwan’s stock market is highly correlated with the Nasdaq, shorting the U.S. tech index can offset losses from a decline in Taiwan stocks.

Attractiveness of U.S. Dollar Assets

Rising interest rates drive the dollar higher, making USD assets the most direct beneficiaries during rate hike cycles. For small investors, dollar-related financial products can capture the yield from dollar interest, serving as a defensive allocation in a rising rate environment.

Conclusion

U.S. rate hikes impact Taiwan’s economy across multiple dimensions—exchange rates, prices, capital flows—and the depreciation of TWD and stock market pressure have become current realities. But within these challenges lie opportunities—smart investors can reallocate assets into USD, adjust stock portfolios, and adopt hedging strategies to turn crises into opportunities. Remember, the rate hike cycle often reverses near its end, and those who grasp the timing can gain an advantage when policy shifts occur.