## How Do Rate Hikes Affect Your Wallet? An Asset Allocation Guide Every Investor Must Know

The topic of interest rate hikes has been frequently making headlines lately, especially as the Federal Reserve's (Fed) rate decisions often trigger stock market fluctuations. But rate hikes are not just numbers; they directly impact our living costs, salary levels, commodity prices, and even investment returns. This article will delve into how rate hikes work, why central banks must raise rates, and how investors should adjust their asset portfolios to navigate the current interest rate environment.

## Understanding Rate Hikes: From Benchmark Rates to Real-Life Impact

**A rate hike essentially means the central bank raising the benchmark interest rate, while a cut is the opposite**. These tools are the core means for central banks to regulate money supply and reflect their assessment of economic conditions. When the central bank adjusts the benchmark rate, the flow of funds, price levels, and employment markets all fluctuate accordingly.

### How Rate Hikes Work

Taking the U.S. Federal Reserve as an example, when the economy is sluggish, the Fed lowers the overnight borrowing rate for banks, enabling banks to finance each other at lower costs and lend to individuals and businesses at cheaper rates. This creates a low-interest-rate environment that encourages borrowing and spending.

Conversely, when the economy overheats and inflation spirals out of control (as in recent years in the U.S.), the Fed raises rates. Borrowing costs for banks increase, and loan interest rates for the public also rise, naturally suppressing consumer spending.

Different countries have varying tools for rate hikes. The U.S. directly influences borrowing costs by adjusting the overnight interbank rate; Taiwan’s central bank adjusts the discount rate to signal monetary policy, with limited direct impact on banks but a clear stance.

### The Core Differences Between Rate Hikes and Cuts

| Aspect | Rate Cut | Rate Hike |
|------|------|------|
| **Definition** | Lowering interest rates | Raising interest rates |
| **Applicable Scenario** | Economic recession or depression | Overheating economy, high inflation |
| **Policy Goal** | Stimulate consumption and economic growth | Increase borrowing costs and cool speculative hot money |
| **Central Bank Attitude** | Dovish (accommodative) | Hawkish (tightening) |
| **Impact on Borrowers** | Costs decrease | Costs increase |
| **Impact on Depositors** | Interest income decreases | Interest income increases |

### Quantitative Standards for Rate Hike Magnitude

Market commonly uses units like "basis points," "half a basis point," "one basis point" to describe the magnitude of rate hikes:

- **Basis Point (BP)**: 0.01%, so 50 BP = 0.50%
- **Half a basis point**: 12.5 BP, or 0.125%
- **One basis point**: 25 BP, or 0.25%

For example, the Fed raised rates multiple times by one basis point in 2022, meaning each time the federal funds rate target increased by 0.75%.

## Why Do Central Banks Choose to Raise Rates?

The ultimate goal of rate hikes is to steer the economy toward a healthy state. When markets overheat and prices soar, raising rates becomes a necessary tool for central banks.

### How Rate Hikes Combat Inflation

Inflation means the same amount of money buys less. For instance, if apples cost $1 a year ago and now cost $2 due to inflation, with wages remaining at $10, purchasing power has declined. Severe inflation erodes consumers’ real purchasing power and negatively impacts the economy.

The logic of rate hikes is as follows: when loan interest rates rise from 1% to 5%, the annual interest on a $1 million loan jumps from $10,000 to $50,000. High borrowing costs discourage consumers and businesses from borrowing to spend or invest, prompting them to deposit cash in banks for higher interest. Reduced demand forces companies to lower prices to stimulate sales, leading to a general decline in prices and curbing inflation.

However, rate hikes also have costs. When demand drops, companies cut production and lay off workers, increasing unemployment and slowing economic growth, potentially leading to recession. This is a risk central banks must weigh when deciding to raise rates.

### Conditions Triggering Rate Cuts

When the economy is in recession and consumer confidence is low, central banks cut rates to stimulate activity. Low or near-zero borrowing costs make loans almost free, and deposit interest is minimal. In such an environment, people and companies prefer to spend rather than save. Increased demand leads to hiring and expansion, reducing unemployment and restarting the economy.

In 2020, with the outbreak of COVID-19, U.S. unemployment surged. The Fed immediately cut rates sharply, bringing the federal funds target rate down to 0%–0.25%. This aggressive move encouraged consumption and investment, ending the recession within two months and beginning economic recovery.

## Factors Driving Rate Hike Decisions

Central banks’ rate hike decisions are influenced by multiple factors:

**Economic Conditions**: In the short term, the strength of the economy determines whether to raise rates. The Federal Open Market Committee (FOMC) regularly assesses economic data and adjusts the overnight rate accordingly. Overheating economies typically trigger rate hikes; weak economies lead to cuts.

**Inflation Trends**: When price indices exceed target ranges, central banks raise the benchmark rate to control inflation. High inflation compels them to increase deposit rates (to attract savings) and raise borrowing costs (to reduce spending), ultimately tightening monetary policy to cool prices.

**Market Demand Structure**: Over the long term, demand for financial assets like bonds influences interest rates. Many commercial loan rates are linked to U.S. long-term Treasury yields rather than directly to the federal funds rate. Increased demand for Treasuries lowers yields; decreased demand pushes yields higher. Rates on credit cards, auto loans, and mortgages are also affected.

## Ripple Effects of Rate Hikes on the Economy and Markets

### Economic Impact

After a rate hike, borrowing costs rise, leading consumers to reduce purchases of big-ticket items like homes and cars. This directly impacts consumption, prompting companies to cut costs, delay equipment investments, or lay off workers. Economic growth slows, and companies may lower prices to maintain sales, achieving the goal of inflation control but at the expense of economic momentum.

### Market Chain Reactions

Higher interest rates exert a dual pressure on listed companies: increased borrowing costs reduce net profits, and declining demand lowers revenue. This often results in falling stock prices, especially for high-growth tech firms reliant on borrowing.

Conversely, bond markets become more attractive. As new bonds are issued with higher yields, bonds become a more appealing low-risk investment. Existing bond prices tend to fall (inverse to yields), but future bond yields for investors increase.

### Currency Market Fluctuations

When rates rise, capital shifts from stocks to bonds, cash, and foreign exchange assets, increasing demand for currencies of high-interest-rate countries. When the U.S. raises rates more aggressively than other countries (e.g., in 2022, the Fed hiked rates sharply while other central banks moved more slowly), the U.S. dollar appreciates against other currencies. Data shows that during the Fed’s aggressive rate hikes in 2022, the USD/TWD exchange rate rose significantly, reflecting increased capital preference for dollar assets.

## Investment Strategies in a Rate Hike Environment

### Tactical Stock Investing

Counterintuitively, the initial phase of rate hikes can be a good time to position in stocks. Legendary investor Warren Buffett has pointed out that buying stocks during high-interest periods can be wise. Although stock prices may dip temporarily during rate hikes, investors who position before the Fed turns to rate cuts can reap substantial gains.

Historical data supports this logic. Over the past 20 years, the Fed experienced two rate hike cycles in 2007 and 2019. After each hike, the S&P 500 declined. But when rate cuts began, the index rebounded and reached new highs. Investors who grasp this rhythm can achieve returns well above average.

### Focus on High-Dividend Stocks

High-dividend stocks become safe havens during rate hike periods. Companies with strong dividend-paying ability often indicate stable management, ample cash flow, and sustainable profits—traits especially valuable during economic uncertainty. Compared to volatile stock prices driven by rising rates, steady dividend income provides regular cash flow, giving investors a sense of certainty amid rising rates.

### Seize Opportunities from Dollar Appreciation

There is a clear positive correlation between the federal funds rate and the strength of the dollar. When the U.S. raises rates faster than other countries, the dollar appreciates against other currencies. Investors can benefit from this trend by increasing allocations in dollar assets, dollar deposits, or dollar-denominated investments.

## Taiwan’s Rate Hike Trajectory and Response

Taiwan’s central bank uses the Discount Rate as its main policy tool. Recently, amid global inflation pressures, Taiwan’s Consumer Price Index (CPI) reached a decade-high in mid-2022. To stabilize prices and curb inflation, the central bank decided to continue raising rates.

In 2022, Taiwan’s central bank increased rates by a total of 2.5 basis points. In 2023, due to CPI exceeding 2% for 19 consecutive months, the bank raised rates another half a basis point to 1.88% in March. Despite concerns over weak exports and ongoing rate hikes, the central bank prioritizes inflation control, and rate increases have not stopped.

### Taiwan Rate Hike Timeline

| Date | Change | Discount Rate |
|-------|---------|--------------|
| 2020.03.20 | Cut 1 basis point | 1.125% |
| 2022.03.18 | Raise 1 basis point | 1.375% |
| 2022.06.17 | Raise 0.5 basis points | 1.5% |
| 2022.09.23 | Raise 0.5 basis points | 1.625% |
| 2022.12.16 | Raise 0.5 basis points | 1.75% |
| 2023.03.23 | Raise 0.5 basis points | 1.875% |

## Evolution of the U.S. Rate Hike Cycle

The U.S. rate hike trajectory reflects economic cycles. In 2019, due to trade tensions with China, the Fed cut rates three times by 1 basis point each to support growth.

In early 2020, the outbreak of COVID-19 triggered a recession, prompting the Fed to implement extreme measures—cutting rates by 2 and 4 basis points consecutively—to bring the federal funds rate down to a historic low of 0%–0.25%. This aggressive easing spurred the economic recovery in 2020–2021.

By June 2022, U.S. inflation hit a 40-year high, prompting rate hikes. Within less than a year, the Fed raised rates from near zero to nearly 5%, an unprecedented speed. With inflation still high, further small increases are under consideration.

## Japan’s Alternative Path

Unlike Taiwan and the U.S., Japan’s central bank has maintained a low-interest-rate policy for years to stimulate the economy. However, at the end of 2022, a shift occurred. The Bank of Japan widened the yield curve control band for government bonds from ±0.25% to ±0.5%, effectively a form of de facto rate hike. This policy adjustment signaled a move away from quantitative easing toward mild tightening. The move directly boosted the yen’s exchange rate, causing the yen to appreciate significantly against the dollar.

## List of Investors in the Era of Rate Hikes

Rate hikes are not just economic phenomena—they are signals for reshaping asset allocation. Investors should remember:

- Rate hikes are tools for central banks to control money supply, stabilize prices, and maintain employment
- Short-term interest rates are driven by economic conditions; long-term rates are demand-driven
- Rate hikes impact stock prices, bond yields, exchange rates, and economic activity but also create opportunities
- Stocks, high-dividend stocks, and foreign exchange assets are key in a rate hike environment
- Historical data shows that early-stage rate hikes can lead to substantial gains during subsequent rate cut cycles

Making rational asset allocation decisions amid the uncertainty of rate hikes is crucial for investment success.