The real challenges Taiwan faces amid the rising interest rate wave

How crazy is this rate hike cycle?

Since 2022, the United States has entered a highly aggressive rate hike cycle. Starting in March, the Federal Reserve raised interest rates by 20 basis points in just 20 months, bringing the benchmark rate from near 0 directly to a range of 5.00%–5.25%. How fast is this? The previous three rate hike cycles are simply incomparable.

Even more astonishing is last year’s four consecutive increases—June, July, September, November—each directly raising by 75 basis points, setting a historical record. The only driving force behind this is controlling inflation. In June 2022, US inflation indicators hit a 40-year high, forcing the Fed into action.

Although inflation is retreating, it is still far from the 2% target. Coupled with the shadow of last year’s banking crisis, market expectations are that rate hikes in the US will not stop here. According to CME FedWatch estimates, there is still room for further adjustments in 2024—gradually decreasing from 5.50% at the start of the year to around 4.00% by the end of the year.

How does the rate hike reshape global asset prices?

The US dollar has become the biggest winner

After rate hikes, higher interest rates increase the returns on dollar deposits, prompting global capital to scramble for USD. In 2022, the US dollar index rose by 8.5%. Behind this seemingly simple phenomenon is a comprehensive appreciation of the dollar against other currencies.

Stock markets are under pressure and it’s a done deal

The logic of rate hikes hurting stocks is straightforward: on one hand, corporate valuations are inversely related to interest rates—the higher the rate, the lower the valuation. On the other hand, rising financing costs directly erode corporate profits. As a result, global stock markets in 2022 were in chaos—S&P 500 down 17%, Nasdaq down 30%.

Entering 2023, stock markets began to rebound, but this was not driven by rate hikes; rather, it was because the rate hike cycle was nearing its end, and markets were speculating on rate cuts.

The contradictory trend of gold

Gold moves inversely to rate hike expectations. When rate hike expectations are strong, gold prices fall; when expectations shift toward rate cuts, gold rebounds. In 2022, gold indeed declined for most of the year, but after November, it rose steadily as the market began to expect the Fed to loosen policy.

The vicious cycle in the bond market

Rate hikes push up interest rates, causing bond prices to fall. Banks holding large amounts of bonds suffer losses as rates rise. Coupled with customer withdrawals, banks are forced to sell bonds for cash, ultimately triggering last year’s US banking crisis.

How Taiwan gets caught in the storm

Exchange rate depreciation is the first impact

The appreciation of the USD means the TWD depreciates. This is not an abstract financial phenomenon but directly affects your purchasing power. US rate hikes → USD appreciation → TWD depreciation.

Inflationary pressures worsen

Taiwan relies heavily on imports, with the US being the most important supplier of agricultural products, accounting for as much as 22.8%. Imported goods are priced in USD, so USD appreciation directly raises import costs. In 2022, Taiwan’s food CPI rose by 6%, with eggs soaring by 26%, driven by rising import feed costs.

Taiwan’s central bank also raised interest rates—five times, totaling 75 bps—but this could not match the large US rate hikes, resulting in the TWD continuously depreciating.

The vicious cycle of capital outflows

Imagine you are an investor: exchanging $100,000 for 2.7 million TWD to buy Taiwanese stocks, earning 300,000 TWD in a year. Initially happy, but then the TWD depreciates by 11%, meaning 3 million TWD can only be exchanged back for $97,000—losing money. The only option is to sell stocks for USD to hedge risks. When most people do this, the stock market naturally becomes volatile and declines.

In 2022, Taiwan experienced capital outflows of $41.6 billion, ranking first in Asia. The same year, Taiwan’s weighted index fell by 21%, ranking sixth from the bottom globally.

Taiwan stocks face pressure, but financial stocks may have opportunities

The logic that rate hikes are negative for stocks involves two points: capital outflows accelerate stock declines, and rising domestic interest rates suppress stock valuations.

But there are exceptions. Financial stocks benefit from widened interest margins on deposits and loans. For example, Taiwan Cooperative Bank’s interest income in 2022 was NT$33.3 billion, up 38% year-over-year, and its stock price also increased by 20%. If you believe in the rate hike cycle, financial stocks are indeed a good direction.

Three strategies for investors

Step 1: Directly buy USD to appreciate

In a rate hike environment, USD appreciation is the most certain trend. Trading USD via forex, futures, or other derivatives can profit from this.

Step 2: Adjust stock allocations

Reduce holdings in high-valuation stocks like tech, and increase positions in high-dividend stocks (especially financial stocks). Hedging risks should be done proactively.

Step 3: Use index hedging

The Taiwan Weighted Index and Nasdaq 100 are highly positively correlated. Shorting Nasdaq 100 can offset losses from a decline in Taiwan stocks. This is a common hedging method used by investors.

Key points to remember

US rate hikes impact Taiwan in multiple ways—TWD depreciation, rising import costs, capital outflows, and stock market pressure. But the rate hike cycle will not last forever. Historical experience shows that the end of a rate hike cycle often sees a reversal. Timely adjustment of strategies and grasping the rhythm are what investors should do.