The Federal Reserve began the process of raising interest rates and shrinking its balance sheet in March 2022.

The U.S. CPI annual growth rate has declined from 9.0% in June 2022 to 3.2% in October 2023, indicating a clear downward trend in inflation.

However, both the CPI and core CPI annual growth rates are still significantly higher than the Federal Reserve's monetary policy targets.

Regarding the future trajectory of the Federal Reserve's interest rate hikes, Zhang Ming, Deputy Director of the Institute of Finance at the Chinese Academy of Social Sciences and Deputy Director of the National Laboratory for Finance and Development, wrote in "Peking University Financial Review" that the Federal Reserve is likely to stop raising interest rates in the future.

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However, considering that it is difficult for the core CPI annual growth rate to fall near 2% in the short term, this means that the probability of the Federal Reserve shifting to a rate cut is low at least in the first half of 2024.

This implies that for at least the next six months, the global economy and financial markets will still have to operate under high short and long-term interest rate levels.

For a considerable period after the global financial crisis in 2008, the world economy was characterized by "three lows and one high" (low growth, low inflation, low interest rates, high debt), indicating a state of secular stagnation.

However, starting from 2021, the U.S. inflation rate began to climb rapidly, reaching a peak of 9.0% in June 2022.

At the same time, developed economies such as the European Union and the United Kingdom also faced increasing inflationary pressures.

The factors contributing to this round of inflation are roughly fourfold: supply-side, demand-side, policy-side, and deep-seated reasons.

From the supply-side perspective, the COVID-19 pandemic in 2020 disrupted global industrial and supply chains, resulting in supply-side shocks; the Russia-Ukraine conflict in 2022 significantly drove up global commodity prices.

On the demand-side, after the outbreak of COVID-19, developed countries like the United States implemented unprecedentedly loose fiscal and monetary policies.

Particularly, large-scale fiscal subsidies targeting households increased temporary income for the residential sector, boosting short-term demand.

From the policy-side perspective, against the backdrop of long-term low inflation, in August 2020, the Federal Reserve announced changes to its monetary policy rules, adopting a long-term goal of 2% average inflation, which means that the Federal Reserve's tolerance for inflation increases in the short term.

Moreover, for a considerable period after the significant rise in U.S. inflation, the Federal Open Market Committee still judged this round of inflation to be temporary, mainly stemming from supply-side shocks caused by the pandemic, and therefore there was no immediate need to contract monetary policy.

However, there are deeper reasons behind this round of inflation, namely the slowdown and even reversal of globalization that has been advancing rapidly since 2018.

In March 2018, the U.S.-China trade war broke out.

From 2020 to 2022, the COVID-19 pandemic raged, and after it ended, with major developed countries pursuing more resilient and controllable industrial chains, there was a trend of fragmentation in global industrial and supply chains.

Both events mean that globalization has encountered headwinds, which will undoubtedly reduce the efficiency of global resource allocation, thereby increasing the production costs of various products and services, and ultimately gradually raising the central level of inflation.

Due to the significant inflation level beyond the central bank's tolerance, the Federal Reserve began the process of raising interest rates and shrinking its balance sheet in March 2022.

So far, the Federal Reserve has raised interest rates 11 times in a row, with a cumulative increase of 525 basis points.

In contrast, the European Central Bank started raising interest rates in July 2022, and so far has raised rates 10 times in a row, with a cumulative increase of 450 basis points: the Bank of England started raising interest rates in December 2021, and so far has raised rates 14 times in a row, with a cumulative increase of 515 basis points.

The central banks of the three major developed economies have collectively raised interest rates so steeply in such a short period, which is very rare in history.

In addition, the Federal Reserve began to shrink its balance sheet in June 2022, initially shrinking by $47.5 billion per month for the first three months, and then by $95 billion per month.

What is the result of the Federal Reserve's interest rate hikes?

The answer is mixed.

On the one hand, as a result of the continuous interest rate hikes and balance sheet reduction, the U.S. inflation rate has indeed declined significantly, with the CPI annual growth rate falling from 9.0% in June 2022 to 3.2% in October 2023.

On the other hand, the core CPI annual growth rate, which the Federal Reserve pays more attention to, has shown stronger stickiness, only falling from 6.7% in September 2022 to 4.0% in October 2023.

Both the CPI and core CPI annual growth rates are still significantly higher than the Federal Reserve's monetary policy targets.

To understand why the U.S. CPI growth rate has strong stickiness, we decompose the U.S. CPI basket into three parts: goods, services, and rent.

Data show that as of October 2023, the annual growth rate of goods prices has fallen to 0.4%, the annual growth rate of service prices is still as high as 5.1%, and the annual growth rate of rent prices is even higher at 6.7%.

The fundamental reason for the high service prices and rent in the United States is that the U.S. labor market is still tight.

The U.S. unemployment rate in October 2023 is only 3.9%, which means that the labor market is still in short supply, and the pressure of wage increases is still very large, which will undoubtedly push up the prices of services and rent.

In other words, before the U.S. unemployment rate deteriorates significantly, the U.S. CPI growth rate, especially the core CPI growth rate, will still have strong stickiness.

Where will the future trajectory of the Federal Reserve's interest rate hikes go?

In fact, since June 2023, the Federal Reserve has raised interest rates only once.

At the interest rate meetings in June, September, and November, the Federal Reserve stopped raising interest rates, and only at the interest rate meeting in July did it announce an increase of 25 basis points.

In other words, since June 2023, the pace of the Federal Reserve's interest rate hikes has clearly slowed down.

The author's prediction is that the Federal Reserve is likely to stop raising interest rates in the future.

However, considering that it is difficult for the core CPI annual growth rate to fall near 2% in the short term, this means that the probability of the Federal Reserve shifting to a rate cut is low at least in the first half of 2024.

This implies that for at least the next six months, the global economy and financial markets will still have to operate under high short and long-term interest rate levels.

Since the Federal Reserve started this round of interest rate hikes in March 2022, there have been varying degrees of financial crises in emerging markets and developing countries such as Sri Lanka, Pakistan, Lebanon, Turkey, Egypt, Ghana, Zambia, and Argentina.

The trigger for the crisis is the rapid interest rate hikes by the Federal Reserve, leading to short-term capital outflows.

Short-term large-scale capital outflows have led these countries to face situations such as currency devaluation, increased foreign debt burden, domestic asset price declines, and pressure on domestic financial institutions.

In the second quarter of 2023, there was a round of banking turmoil in Europe and America.

So far, three banks in the United States have gone bankrupt, namely Silicon Valley Bank, Signature Bank, and First Republic Bank.

Both Silicon Valley Bank and First Republic Bank are medium-sized banks ranked between 10th and 20th in the United States.

The common reason for the bankruptcy of these three banks is that their assets purchased a large amount of government bonds and high-grade institutional bonds.

The market value of these bonds has shrunk significantly against the backdrop of rapid upward movement of benchmark interest rates, which has triggered anxiety among depositors.

The latter voted with their feet and began to run, eventually triggering a classic banking crisis.

Later, with the joint rescue of the U.S. Treasury, the Federal Reserve, and the Federal Deposit Insurance Corporation, the crisis did not expand further.

European banks such as Credit Suisse and Deutsche Bank were also involved in the crisis.

In addition to the paper losses on the asset side, these two banks also have more serious corporate governance issues.

Considering that the U.S. short and long-term interest rates will still operate at high levels for some time in the future, will this lead to new risks?

Currently, there are two potential risks that the U.S. market is more worried about.

One is that the U.S. corporate bond market, especially the high-yield corporate bond (junk bond) market, has a greater potential risk.

The rise in risk-free interest rates and risk premiums will significantly increase the pressure on enterprises to repay principal and interest, and whether they will face a collective default in the future is still unknown.

The second is that the U.S. real estate market, especially the commercial real estate market, faces adjustment pressure.

The rise in benchmark interest rates will push up the interest rates of real estate mortgages, which will lead to adjustments in the real estate market.

The COVID-19 pandemic has changed the office mode of small and medium-sized enterprises to some extent, and the rise of remote office has reduced the demand for the purchase and lease of commercial real estate, so the commercial real estate market faces significant adjustment risks.