The Federal Reserve's interest rate hike impacts Taiwan's economy, with the Taiwanese dollar depreciating and the stock market under pressure, creating a double dilemma.

How US Rate Hikes Affect Taiwan: An In-Depth Chain Reaction Analysis

Since the start of the rate hike cycle in March 2022, the US has raised interest rates by a total of 20 basis points, with the benchmark rate soaring from near zero to the 5.00%-5.25% range. This round of aggressive rate hikes is unprecedented in history—the Federal Reserve has increased rates at every one of its ten meetings, with consecutive hikes of 75 bps in June, July, September, and November 2022. All of this stems from the inflation crisis that saw the US Consumer Price Index reach a 40-year high in June 2022.

Although market expectations for further rate hikes in 2024 have cooled, inflation has yet to return to the 2% target, and financial stability risks present new variables. According to the CME FedWatch tool, the Federal Reserve still has room to cut rates in 2024, but the timing and magnitude remain uncertain.

Why Do Rate Hikes Depreciate the TWD? Microeconomic Logic of the Forex Market

The US dollar appreciation is a direct consequence of rate hikes. When the US raises interest rates, foreign capital floods into USD assets to earn higher deposit yields, increasing demand for the dollar and pushing its price higher. In 2022, the US dollar index rose by 8.5%, making it the strongest currency globally.

In contrast, the Taiwan Central Bank’s rate hikes have been modest—by 75 bps over five increases as of 2023. Since Taiwan’s rate hikes are much smaller than those in the US, the TWD has shown a one-way depreciation against the dollar. This means that USD-denominated assets priced in TWD are becoming increasingly expensive.

The Real Impact of TWD Depreciation: Rising Import Prices and Inflation Transmission

Currency depreciation directly raises import costs. For example, the US is Taiwan’s most important agricultural supplier, accounting for 22.8% of Taiwan’s agricultural imports in 2022. Since imported goods are priced in USD, a stronger dollar effectively increases import costs. In 2022, Taiwan’s food CPI rose by 6%, with egg prices soaring by 26%. The root cause was the skyrocketing cost of imported feed.

This inflation transmission exerts real pressure on consumers’ living costs, especially in categories reliant on imported goods.

Capital Outflows: The Hidden Killer Often Overlooked

TWD depreciation triggers large-scale capital flight. Imagine an overseas investor exchanging US$100,000 for NT$2.7 million to buy Taiwan stocks, earning NT$300,000 in a year. However, with the TWD depreciating by 11%, NT$3 million can only be exchanged back for US$97,000—resulting in a loss. Facing this situation, rational investors tend to sell stocks and convert to USD for safety.

When many investors sell simultaneously, the stock market can become volatile. According to Taiwan’s Stock Exchange, in 2022, capital outflows reached US$41.6 billion, the highest in Asia, accounting for over 70% of the continent’s total outflows.

How Do Rate Hikes Impact Taiwan’s Stock Market Performance?

Rate hikes exert a double blow on the stock market. First, USD appreciation leads to capital outflows, directly weakening Taiwan’s stock liquidity. Second, the Taiwan Central Bank’s rate hikes raise domestic interest rates, increasing corporate financing costs and reducing profits. Additionally, stock valuations are downwardly revised due to higher discount rates.

This explains why the Taiwan Weighted Index fell 21% in 2022, ranking sixth from the bottom globally. In comparison, the US stock market also faced the impact of rate hikes—S&P 500 down 17%, Nasdaq down 30%—but began to rebound in 2023 as investors anticipate the Fed’s rate hike cycle may be nearing its end.

Investment Opportunities in a Rising Rate Environment: Financial Stocks as Winners

Not all stocks are negatively affected by rate hikes. Financial stocks, especially banks, tend to benefit. The reason is simple: rate hikes widen the interest margin, increasing banks’ interest income. For example, Taiwan Cooperative Bank’s interest income reached NT$33.3 billion in 2022, up 38% year-over-year, with its stock price rising 20%.

For investors seeking to capitalize on rate hike benefits, increasing allocations to financial stocks and high-dividend-yield stocks is a viable strategy.

Gold and Bonds: Divergent Performances Under Rate Hikes

Gold and rate hike expectations have an inverse relationship. When rate hikes intensify, gold prices tend to fall. Conversely, when the pace of hikes slows or rate cut expectations emerge, gold prices often rise. Gold declined steadily before November 2022 but started an upward trend from December.

The bond market faces more direct impacts. Rising interest rates push up yields, and bond prices move inversely to yields, making rate hikes negative for bonds. The 2023 US banking crisis partly originated from banks holding bonds that depreciated significantly due to rate hikes, forcing them to sell at a loss, creating a vicious cycle.

2024 Federal Reserve Policy Outlook and Taiwan’s Perspective

Market forecasts suggest a higher likelihood of rate cuts in 2024, but the exact pace remains dependent on inflation and financial stability developments. If the rate hike cycle indeed ends, the TWD may find some relief, and capital outflows could ease. However, in the short term, Taiwan’s economy still faces the lingering effects of high interest rates.

How Ordinary Investors Can Respond

During a rate hike cycle, investors can adopt the following strategies:

Strategy 1: Capitalize on USD Appreciation
Rate hikes drive USD higher. Investing in USD or USD-denominated assets is a direct way to benefit. Whether through forex trading, futures, or leveraged instruments, investors can participate in the USD rally.

Strategy 2: Adjust Stock Portfolio
Reduce holdings in high-valuation stocks like Tech Stocks, and increase allocations to financial stocks and high-dividend-yield stocks to mitigate valuation pressures from rate hikes.

Strategy 3: Use Short Selling for Hedging
Taiwan’s TAIEX and the Nasdaq 100 are highly correlated. Shorting US stock indices can partially offset losses in Taiwan stocks, providing a hedging effect.

Conclusion

US rate hikes have a comprehensive impact on Taiwan’s economy—depreciating the TWD, boosting import inflation, triggering capital outflows, and raising corporate financing costs. However, every financial cycle contains opportunities. The key is to accurately identify the stage of the rate hike cycle and balance risks and opportunities precisely. The end of a rate hike cycle often signals a market reversal, and timely adjustment of investment strategies can help seize opportunities amid economic transitions.