The US Federal Reserve has enacted a 25 basis point rate increase, marking its first hike in three years. This move is set to reverse the risk-management easing that the Fed initiated in 2025, according to a report from Deutsche Bank Research following the Federal Open Market Committee (FOMC) meeting. Both Deutsche Bank Research and Morgan Stanley anticipate two further 25 basis point hikes in December 2026 and March 2027, respectively.

UBS projects two rate increases in 2026, with a potential third if monthly core inflation approaches 0.3% in the second half of the year and the proportion of components rising above 3% increases. However, the second hike could be delayed if average annual US inflation falls below 2% by October 2026 and the six-month annualized inflation rate drops under 2.5%.

Given that markets had largely priced in this hike, the "shoe dropping" has resulted in a generally stable global financial market response, though asset performances diverge. US Treasury yields remain elevated, with the 10-year yield near 5%. Spot gold briefly fell below $4,240 per ounce, down 1.29% intraday, before rebounding to $4,297.91 per ounce by 1 PM. US stocks closed lower, with the Dow Jones falling 1.21% to a mid-June low, the S&P 500 down 0.45%, and the Nasdaq down 0.01%. The US dollar index has climbed above 100.

Turning to China, the Renminbi (RMB) exchange rate and stock market have shown divergent trends. The RMB remains in an appreciation trend against the dollar, with the onshore rate up over 0.05% and the offshore rate up over 0.07% intraday by 12:42 PM. In contrast, Chinese equities are under pressure, with the Shanghai Composite Index down over 0.36%, the Shenzhen Component Index down over 0.29%, and Hong Kong's Hang Seng Index and Hang Seng Tech Index down over 0.73% and 0.763%, respectively, by midday break. Additionally, the China-US interest rate differential remains inverted, with the spread between 10-year US Treasury and Chinese government bond yields exceeding 330 basis points by 12:17 PM.

Qu Qiang, Vice Dean of the Institute of Regional and Country Studies at Minzu University of China, notes that the Fed's hike itself has limited direct impact on China, but it tightens the "imagination space" for a fourth-quarter domestic rate cut. With ample domestic liquidity and a strong RMB providing a buffer, the direction of China's stock, bond, and FX markets is unlikely to change. Key variables to monitor include whether the Fed follows through with a second hike in December and whether the RMB can sustain its independent strength despite a widening interest rate differential.

Multiple central banks have followed suit. The Fed's decision, passed 12-0, raises the federal funds rate target range to 3.75%-4.00%, citing persistently high inflation aimed at returning to the 2% target. Among 18 officials submitting dot plot projections, 16 favored another hike in 2026, with four expecting a cumulative 75 basis point increase and 12 expecting 50 basis points. CME FedWatch data shows the market probability of a 25 basis point hike in October at 49.1%, up from 41.6% a month ago, while a 50 basis point hike is priced at 50.9%, a significant jump from 7.2%.

Deutsche Bank Research believes the US is entering a rate-hike cycle, projecting a total of 75 basis points in increases, including this one, by March 2027. Jim Reid, Global Head of Macro Research and Director of Deutsche Bank Research Institute, notes that three consecutive hikes would aptly constitute a cycle. However, Hu Jie, a professor at Shanghai Jiao Tong University's Shanghai Advanced Institute of Finance and former senior economist at the Fed, argues this may not necessarily signal a prolonged cycle, as the future path depends on inflation data. Cooling trends in CPI, core CPI, PCE, and core PCE suggest easing, but pressures persist, making late-September PCE and mid-October CPI data crucial.

Following the Fed's announcement, the Hong Kong Monetary Authority raised its base rate by 25 basis points to 4.25%, while central banks in Saudi Arabia, the UAE, and Qatar also increased rates by 25 basis points across various instruments. Regarding the impact on China's monetary policy, Qu Qiang suggests that constraints on the People's Bank of China are marginally tightening, with policy rate differentials deepening and expectations of RMB depreciation and capital outflows weighing. However, the primary focus remains domestic growth and demand, as emphasized by the central bank's "maintain ample liquidity" stance. Hu Jie adds that China, not facing inflation concerns, prefers lower rates to stimulate the economy, making a rate hike unlikely.

The Fed's rate increase has not derailed the RMB's appreciation trend, with onshore and offshore rates at 6.7083 and 6.7076, respectively, by midday. Qu Qiang warns of short-term depreciation pressure, but whether it becomes medium-term depends on the Fed's hawkishness and market expectations. A "higher for longer" path could deepen interest rate inversions, boost dollar asset allocations, and encourage exporters to delay forex settlement, tilting the RMB's medium-term trajectory downward. However, he stresses that China's monetary policy has maintained significant independence, with the RMB's mid-term path historically driven by current account, capital flows, and policy credibility, not solely by Fed decisions.

Hu Jie highlights interest rate differentials, trade balances, and investment flows as key exchange rate factors. Despite higher US rates attracting some RMB holders, controlled conversion channels limit arbitrage-driven capital outflows. Conversely, China's substantial trade surplus with the US, reaching $199.82 billion from January to August 2026, up from $185.845 billion a year earlier, supports RMB appreciation. Chinese equities remain under pressure, with indices closing lower at midday, while a China International Capital Corporation (CICC) report notes that sustained Fed hikes could affect A-shares through funding costs, dollar strength, and reduced overseas demand impacting Chinese exporters. However, if the hike is short-term or isolated, the impact would be limited, given recent market reactions and a 2.62% decline in the Shanghai Composite and 3.33% drop in the Shenzhen Component since September.

In the bond market, the China-US yield spread remains deeply inverted, with China's 10-year government bond yield at 1.68%, creating a differential exceeding 330 basis points. Looking ahead, a September report from Guotai Haitong Securities suggests that the Fed's rate hike primarily affects domestic bonds through sentiment rather than substantive capital flow or monetary policy constraints. The transmission mechanism via the RMB exchange rate is weak, as current pressure favors appreciation, with trade-related forex settlements having a stronger impact than interest differentials. Even if the dollar strengthens temporarily, China's monetary policy is likely to remain "self-oriented." Furthermore, additional US rate hikes could suppress overseas equity valuations and manufacturing activity, indirectly supporting Chinese bonds through risk appetite and external demand channels.