In-Depth Analysis of the U.S. Interest Rate Hike Mechanics and Global Financial Flows

Why do global investors pay close attention to U.S. interest rate hikes? Because it directly determines the flow of global capital and the prosperity or recession of financial markets. When the U.S. enters a rate hike cycle, funds tighten quickly, and the stock market often enters a bear market; when a rate cut cycle begins, liquidity is abundant, and various assets generally rise. This is not a coincidence but is determined by the deep-seated monetary policy transmission mechanism. To understand how U.S. rate hikes affect the world, first understand what the Federal Reserve actually is and why it repeatedly raises and lowers interest rates.

The Dual Identity of the Federal Reserve and Its Monetary Policy Goals

The Federal Reserve (the Fed) is nominally the central bank of the United States, but in reality, it wields far greater global influence than central banks of other countries. This is because the U.S. dollar’s status as the world’s reserve currency allows the Fed to act as the “world’s central bank.” Although the Federal Reserve Board is nominated by the President and confirmed by Congress, it maintains institutional independence and is not part of the U.S. government. This independence grants the Fed autonomy in setting monetary policy.

From a policy goal perspective, the Fed narrowly focuses on two core economic indicators: the unemployment rate and inflation rate. When unemployment falls below 5.6% and inflation exceeds 3%, the Fed prioritizes controlling inflation, entering a sustained rate hike cycle; when unemployment exceeds 4% and inflation is below 3.7%, the Fed stops raising rates. In other words, U.S. rate hikes are a passive policy choice, fundamentally based on the logic of “using higher financing costs to suppress excessive social purchasing power.”

The Money Printing Process Before U.S. Rate Hikes: “Left Hand Giving, Right Hand Receiving”

To understand how U.S. rate hikes produce global effects, first grasp how the Fed injects money into the market. This process may seem complex but can be simplified into three stages.

First, the Fed cannot directly print money. According to the Federal Reserve Act, issuing currency must be backed by assets. Historically, these assets were precious metals or securities; now mainly U.S. Treasuries. So, if the Fed wants to print money, it must first obtain U.S. Treasuries from the Treasury Department as collateral, then notify the Bureau of Engraving and Printing to produce new dollar bills.

Second, the newly printed dollars must enter the market to be considered actual monetary supply. At this point, the U.S. government plays a role. It needs Congressional approval to issue new debt. Cleverly, government debt issuance and Fed money printing are synchronized—this is the so-called “left hand giving, right hand receiving.” The amount of dollars printed corresponds to the amount of new U.S. Treasuries issued. The Fed uses these new dollars to buy the newly issued government bonds, thus injecting new money into the U.S. government and markets.

Finally, the Fed holds these U.S. Treasuries as assets. When it needs to print more money again, it uses these Treasuries as collateral with the Treasury Department, repeating the cycle. Although complex, the core is: the U.S. government borrows, the Fed prints money to buy these bonds, and new money enters the market.

The Transmission Mechanism of U.S. Rate Hikes: From Central Bank to Market Participants

Once you understand the money printing process, it’s easier to see how U.S. rate hikes exert their power. U.S. rate hikes are essentially two combined actions: raising interest rates and shrinking the balance sheet, simultaneously.

Microfoundation of Rate Hikes

U.S. rate hikes target the “federal funds rate.” This rate sounds unfamiliar but influences all commercial banks’ borrowing costs. U.S. commercial banks are required to hold “reserve deposits” at the Fed. When banks are short of funds, they borrow from other banks to meet reserve requirements. The interbank lending rate (the overnight borrowing rate) is not directly set by the Fed but is market-determined. However, the Fed influences this rate by raising the “Interest on Excess Reserves” (IOER) and the “Overnight Reverse Repurchase Rate” (ON RRP).

When these two rates rise, banks find it more profitable to deposit excess reserves at the Fed rather than lend to other banks. As a result, banks compete to lend to the Fed, reducing interbank lending and causing the interbank rate to rise. This makes it more expensive for banks to borrow from each other, increasing overall financing costs in the financial system.

Balance Sheet Reduction and Asset Effects

At the same time, the Fed conducts “balance sheet reduction”—selling the U.S. Treasuries it previously purchased. Typically, a bond worth $100 with a 10% annual yield might be sold at $80. Holding this bond for a year yields $110 (principal + interest), giving an annual return of (110-80)/80×100%=37.5%. Such high yields attract commercial banks to buy these discounted Treasuries.

Why are banks so eager to buy Treasuries? Because of the high interest and because U.S. Treasuries are the highest-grade assets recognized by the central bank, easily convertible to cash when needed. Once banks hold large amounts of Treasuries, their capital allocation becomes locked—since Treasuries offer high returns and are highly liquid, banks are less willing to lend to businesses.

The Impact of U.S. Rate Hikes on Various Markets

After a rate hike begins, a chain reaction unfolds, with each reaction linked to the next.

Stock Market Crash

First, the stock market. Retail investors and small institutions in the U.S. notice: bank interest rates are higher (banks raise deposit rates to attract funds), and these are safe. Compared to stocks, which carry higher risk and uncertain returns, many funds withdraw from equities, leading to declining stock prices. However, major investors like Warren Buffett won’t fully exit—they may use their funds to support the market, preventing a total collapse and creating a false appearance of stability. When Buffett decides “the time to withdraw is right,” he may sell off at high prices, trapping retail investors and small funds.

Rising Corporate Financing Costs

With rates rising, banks’ funds are largely used to buy Treasuries and pay reverse repo interest, leaving less available for corporate loans. Moreover, as U.S. interest rates rise, the economy shows signs of slowdown, credit ratings of companies decline, and banks become more cautious. Even if companies are willing to pay 50% interest on loans, banks may hesitate—since lending to the Fed yields “risk-free returns.” When companies can’t borrow, their capital chains break, leading to bankruptcies and unemployment.

Personal Consumption and the “Save or Spend” Dilemma

Ordinary people react oppositely. As stock prices fall and risky assets depreciate, and with bank deposit rates rising, people tend to withdraw money from consumption and investments and deposit it in banks. This significantly reduces circulating currency, making each dollar more valuable. With less consumption, merchants are forced to lower prices, leading to deflation. This is the ultimate goal of U.S. rate hikes.

Floating-Rate Loan Crisis

Most corporate and personal loans in the U.S. are floating rate, initially low and easy to approve. But once rates rise, subsequent interest payments increase. Borrowers must quickly convert their holdings into dollars to repay debts, or interest will snowball. This causes holders of dollar-denominated loans worldwide to scramble to exchange currencies to repay debts, driving the dollar higher—an important driver of dollar appreciation during rate hikes.

The “Harvest” of Global Markets During U.S. Rate Hikes

The global impact of U.S. rate hikes is immediate. For example: before a rate hike, a dollar investor used $100,000 to buy a house in Europe. Years later, inflows of dollar hot money pushed the property price to $180,000. When the Fed announces a rate hike, the investor realizes: the dollar has appreciated (due to higher U.S. returns), and the euro has depreciated. The house worth $180,000 now has limited appreciation potential. The smartest move is to sell the house, convert $180,000 back to USD, and deposit in a high-interest account in the U.S. This way, both principal and gains are transferred back to the U.S.

This logic applies to all international assets—local stocks, bonds, luxury cars, yachts, corporate shares, precious metals, luxury goods, antiques, etc. Global investors are playing the same game: sell local assets, buy dollars, flow into the U.S. market. The result is a sharp decline in asset prices in target countries. A house bought for $100,000 might now only be worth $30,000. The slower the sell-off, the greater the loss. This is why emerging markets often experience financial crises after U.S. rate hikes.

Dollar as a Geopolitical Tool

Another key point: the Fed often signals geopolitical tensions to ensure dollar repatriation. Each U.S. rate hike cycle is usually accompanied by conflicts, energy crises, regime changes, or food shortages in certain countries. This is not coincidence but a deliberate way to guide global capital to perceive “the U.S. as the safest.” It’s a tried-and-true tactic used over decades.

The Rate Cut Cycle: The “Foraging” Moment for Global Capital

When U.S. unemployment rises to around 5% or core PCE inflation drops to 2%, the Fed begins to cut rates. This signals an impending “economic recession,” requiring loose monetary policy to stimulate growth. Rate cuts involve two actions: lowering the federal funds rate and expanding the balance sheet (quantitative easing).

Two Methods of Expanding the Balance Sheet

The primary method is the Fed repurchasing large amounts of Treasuries it previously sold. The process reverses: Treasuries return to the Fed, dollars flow back to commercial banks, and new dollars re-enter the market.

Second, the Fed directly prints money. The process: the Fed registers assets with the Treasury, requests authorization to print money, and the Treasury simultaneously issues new Treasuries. The Fed then buys all these new Treasuries. This results in both new dollars and new Treasuries flowing into the market and government.

Massive Treasuries and dollars are concentrated in the Fed’s balance sheet, rapidly expanding its assets. Treasury yields fall, and the dollar begins to depreciate. A weaker dollar means that assets priced in dollars (when converted to other currencies) increase in value. At this point, the released dollars act like a ravenous wolf unleashed, rushing into any opportunity for appreciation.

Banks Actively Lending, Companies and Individuals Borrow Frenziedly

With abundant dollars, banks start actively lending, even lowering interest rates to near zero. Companies and individuals, finding borrowing cheap, borrow extensively for production and consumption. Bank deposits decline sharply (as some borrow, others withdraw to invest). Companies expand, hire more staff, and unemployment drops. Consumption and money circulation increase, pushing prices upward—leading to inflation.

Global Asset Booms

As interest rates fall, people and capital shift from savings to spending and investing. Large amounts of dollars flow into stocks, real estate, forex, precious metals, and other risk assets. Since U.S. markets can’t absorb all this liquidity, dollars flow globally, seeking undervalued assets. Everywhere, asset prices soar: stock markets rise, property prices climb, exchange rates appreciate, and prices inflate.

This is why rate cut cycles often lead to global prosperity—new dollars continuously injected into markets push up the prices of all dollar-denominated assets.

Policy Cycles: Theory and Practice

Assuming other variables remain constant, in theory, U.S. rate cuts will lead to:

• U.S. stocks rise
• U.S. bonds rise
• Other countries’ stocks rise
• The dollar depreciates
• Other currencies appreciate
• Gold prices rise
• Oil prices rise
• U.S. housing prices rise
• Cryptocurrencies rise

Conversely, U.S. rate hikes tend to cause most of these assets to fall. But in reality, variables never stay constant, which is why market performance often exceeds expectations.

The decision to stop rate cuts and resume hikes depends on two key indicators: unemployment rate and inflation index. Once these indicators again become unbalanced, a new policy cycle begins. Each cycle reshuffles global capital allocation. Understanding the logic of U.S. rate hikes and cuts is fundamental to understanding the movement of global financial markets.