The Federal Reserve's interest rate hike wave is coming. How should Taiwanese investors respond?

U.S. Rate Hike Process Review and 2024 Outlook

The rate hike cycle that began in March 2022 has accumulated a total increase of 20 basis points (500 basis points), with the U.S. benchmark interest rate rising from near zero to the 5.00%–5.25% range. This round of rate hikes has been unprecedented in speed — in June, July, September, and November 2022, the Federal Reserve consecutively raised rates by 75 basis points each time, driven by inflation pressures that pushed the U.S. Consumer Price Index to a forty-year high in June 2022.

Although inflation has started to decline, it remains above the 2% target, and the market generally expects the Federal Reserve to have room to cut rates in 2024. Based on market expectations, the Fed will gradually adjust its policy rate over eight meetings throughout the year, with the rate possibly falling to around 4% by the end of the year.

How Does the Rate Hike Chain Reactively Transmit to Taiwan?

Malicious Cycle of Exchange Rate and Prices

The most direct effect of rate hikes is strengthening the U.S. dollar. Higher U.S. interest rates → increased attractiveness of dollar assets → large foreign capital inflows into USD → USD appreciation, while the Taiwan dollar (TWD) correspondingly depreciates. In 2022, the TWD depreciated by 11% against the USD. This seemingly simple exchange rate fluctuation actually impacted Taiwan’s prices through imported goods.

Over one-fifth of Taiwan’s imported agricultural products come from the U.S., and imported commodities like feed and grains are all priced in USD. The depreciation of the TWD directly raises import costs, leading to a 6% increase in Taiwan’s food CPI in 2022, with egg prices soaring by 26%. The root cause lies in rising import feed costs. Even after the central bank raised rates five times (a total of 75 basis points), the magnitude was still far less than the Fed’s, unable to effectively halt the TWD’s decline.

Capital Outflows and Stock Market Volatility

Depreciation triggers another chain reaction — capital outflows. Foreign investors, after currency conversion losses, sell stocks and exchange USD for risk hedging. In 2022, Taiwan experienced a record capital outflow of $41.6 billion, the highest in Asia. The stock market thus faced dual pressures: on one hand, capital withdrawal caused selling pressure; on the other hand, the central bank’s rate hikes increased local financing costs and lowered corporate valuations. As a result, the Taiwan Weighted Index fell by 21% in 2022, ranking sixth from the bottom globally.

Winners and Losers in the Rate Hike Environment

Not all assets suffer during a rate hike cycle. The widened interest rate spread significantly boosts profits for financial institutions — for example, Taiwan Cooperative Bank’s interest income grew by 38% in 2022, with its stock price rising by 20%. Conversely, high P/E ratio tech stocks and growth stocks are hit hardest due to valuation compression.

The bond market also faces pressure. Rising interest rates push up bond yields, causing existing bond prices to fall. Banks holding large amounts of bonds suffer losses, which contributed to some aspects of the 2023 U.S. banking crisis.

Three Key Investor Strategies

Strategy 1: Increase Holdings in USD-Related Assets

Since rate hikes boost the dollar, it’s logical to participate directly. Whether through bank currency exchanges, futures, or CFDs, investors can profit from USD appreciation. Small investors can leverage CFDs’ high leverage to participate in USD index fluctuations with minimal capital.

Strategy 2: Rotate Stock Positions

Reduce holdings of high-valuation stocks and shift toward high-dividend-yield stocks, especially financial stocks benefiting from rate hikes. Besides individual stocks, related ETFs are convenient options, providing broad industry exposure in one trade.

Strategy 3: Deploy Hedging Tools

Taiwan’s stock market has a high correlation with the Nasdaq Index. Investors can hedge against Taiwan stock declines by shorting U.S. stock indices, achieving risk management for their portfolios.

Timing the Key Turning Points

The end of a rate hike cycle often harbors reversal opportunities. When market expectations shift from “continued rate hikes” to “policy pivot,” stock markets often rebound, and safe-haven assets like gold also gain buying interest. Investors should closely monitor Federal Reserve signals and adjust their positions accordingly at policy turning points.