In recent times, the dynamics surrounding interest rate hikes by the Federal Reserve (Fed) have stirred much speculation among investors and analysts in the stock marketWhen the Fed announces an increase in rates, it often causes immediate turbulence in financial marketsThis is due to the implications that higher rates have on borrowing costs, consumer spending, and ultimately, economic growthHowever, as history illustrates, the mid-term effects of rate changes tend to align closely with underlying economic fundamentalsTherefore, the question arises: what should investors anticipate in light of recent developments?

In January, the U.SConsumer Price Index (CPI) adjusted year-on-year reached an astounding 7.5%, marking the highest inflation rate since 1982. With such inflationary pressures, the Fed's stance has clearly shifted towards a more hawkish approach

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As markets speculate, there’s a notable consensus that the likelihood of a rate hike being announced during the March Federal Open Market Committee (FOMC) meeting is at an all-time high—100% to be preciseWhat ramifications will this have moving forward?

Historically, we can look back at previous cycles of interest rate increases led by the FedThe three notable periods occurred from June 1999 to May 2000, from June 2004 to June 2006, and December 2015 to December 2018. Notably, each of these cycles coincided with a phase of strong economic growth characterized by continuous inflation risesThis indicates that such hikes often occur in an overheated economy where demand is robust.

For the global equity markets, every initiation of a new rate hike cycle by the Fed has generally resulted in a cooling-off period for stock prices

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For instance, the S&P 500 experienced a peak-to-trough decline of between 5% to 15%, while markets in Asia, like the Hang Seng Index and the Shanghai Composite Index, have seen pullbacks ranging from 15% to a staggering 30%. Yet, when viewed over a longer horizon, equity markets rebound after such adjustments, as with the improvement in their respective economic fundamentals fostering renewed investor confidence.

Focusing on the A-share market, it's essential to consider how the Fed's interest rate decisions influence market sentiment in the short termThe correlation between A-shares and international markets notably increased after the Shanghai-Hong Kong Stock Connect opened in November 2014. Therefore, it’s valuable to analyze the initial response of the A-share market to the Fed’s recent rate hike initiatives.

In December 2015, after the Fed announced an interest rate hike, the S&P 500 saw a decline of approximately 13% from December 2015 to February 2016. At the same time, China’s 10-year Treasury yields were on a downward trajectory

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Unfavorably influencing the A-shares was innovative market mechanisms such as the circuit breaker and the fears surrounding the economy due to supply-side reformsIn this context, the Fed's interest hike served as a catalyst for market panicHowever, by December 2016, after the second rate hike, China’s economic fundamentals had begun to improve, leading to a much subdued market reaction, with only about a 5% drop in the Shanghai Composite between November 2016 and January 2017.

From a long-term perspective, the impact of the Fed’s interest hikes on A-shares is largely mediated through the lens of China's monetary policyHistorically, while monetary policies of China and the U.Sdiverged at times, they have shown significant correlation in times of unified inflation cycle concernsWhen the Fed tightens its monetary policy to combat domestic inflation, China finds itself under similar pressures, leading to an eventual tightening in domestic rates

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Such tightening poses a restraint on the valuation of A-shares, underscoring the interdependence between global monetary policy and local market sentiments.

When reviewing market styles during periods of Fed rate increases, it has been observed that large-cap value stocks typically outperform their small-cap growth counterpartsFor example, during the period from May 2004 to August 2005, the ratio of large-cap stocks relative to small-cap stocks surged from 1.15 to 1.47. Similarly, from December 2015 to December 2018, this ratio climbed from 0.44 to 0.82, along with corresponding gains in the value versus growth indices.

Currently, while the onset of the new interest rate cycle by the Fed has not been officially confirmed, market participants have begun to adjust their expectationsThe potential ramifications on major asset classes are already visible, as evidenced by market movements over the past few months.

Focusing specifically on the A-share market, adjustments prompted by ongoing geopolitical conflicts coupled with anticipated Fed rate hikes have already triggered certain market fluctuations

Looking forward, the markets will likely revert to their underlying operational logicAt this critical juncture, the spring rally in A-shares remains a beacon of optimism for investors for two main reasons: First, the effects of policies aimed at stabilizing growth are beginning to materializeThe People’s Bank of China recently adjusted interest rates on various lending instruments, injecting liquidity into the economy, as shown by a significant year-on-year increase in social financing in JanuaryFurthermore, the Ministry of Finance has proactively allocated a notable amount of special bonds ahead of schedule.

The second reason is historically founded; A-share markets have not missed a spring rally in the past two decadesThis can be attributed to the prevalence of high-stakes meetings during this period, along with the reduction in data disclosures which limits potential negative sentiments affecting investments, leading to an overall increased risk tolerance among investors as the new year begins.