Since early August, the consecutive weakening of economic data such as non farm payroll and PMI has raised concerns about a recession. In addition, the reversal and amplification of the yen's interest rate trading have led to severe asset volatility, and expectations for the Federal Reserve to cut interest rates have suddenly risen to several consecutive 50bp starting points, even to the point of emergency meetings to cut interest rates. After several weeks of digestion, the market has largely recovered its lost ground, which is consistent with our expectation that although liquidity will tighten, it is not impossible to solve ("New Issues in Hedge Trading and Liquidity Shock"). The expectation of interest rate cuts has also rebounded from 50bp to the "normal level" of 25bp, but the market's recession concerns have not completely dissipated. In fact, since the beginning of this year, the expectation of interest rate cuts has fluctuated several times and violently, and we have always adhered to the judgment of "being able to cut interest rates but not needing a lot" (Global Market Outlook for the Second Half of 2024: Half of the easing has been done).
Despite strong expectations and long brewing of interest rate cuts, Federal Reserve Chairman Powell's personal and explicit suggestion at the Jackson Hole meeting that a rate cut is about to be initiated still attracts widespread attention. From an asset perspective, the interest rate cut cycle is finally about to begin, which means a further strengthening of current trading? Or is it possible that it's almost coming to an end? We provide some new ideas and suggestions for addressing common "misconceptions" in the market, suggesting a slight reversal of thinking or even doing the opposite, which may have a better effect.
1. Time of interest rate cut: The September interest rate cut is basically confirmed, and the Federal Reserve's focus shifts from inflation to employment
Powell's speech is almost equivalent to announcing the September interest rate cut ahead of schedule, highlighting the shift in focus towards the job market. The hawkish stance of the Federal Reserve in the past was mainly based on inflation expectations, and concerns about the risk of secondary inflation rising again if early trading and interest rate cuts were implemented. At the Jackson Hole meeting, Powell changed the wording of the policy objective with a higher inflation weight, using terms such as a decrease in inflation risk and an increase in employment risk, indicating a shared focus on these two risks. Powell has shown stronger confidence in the issue of inflation, stating that inflation expectations are well anchored and inflation is much closer to our objective. These statements can basically be seen as announcing a victory in the fight against inflation. In contrast, Powell's speech this time gave more space to discussing employment than inflation, especially compared to his speech in 2023, which was almost entirely focused on discussing inflation issues. Powell believes that the job market has cooled significantly from overheating, and it is difficult for the job market to cause inflation to rise again.
At present, the market has fully taken into account the September interest rate cut. We pointed out in the FOMC review in July ("September interest rate cut gradually approaching"), and the minutes after the FOMC meeting in July also showed that the vast majority of participants had expressed support for the September interest rate cut. The Jackson Hole meeting gave a clearer statement that the time has come for policy to adjust. Before the meeting, the September interest rate cut was already a certainty. After the meeting, CME interest rate futures included a 100% probability of a September interest rate cut, with a 76% probability of a 25bp cut and a 24% probability of a 50bp cut.
Chart: The market expects the probability of a September interest rate cut to reach 100%
Source: CME, Research Department of CICC
2、 Path of interest rate cut: magnitude and path are more important, but 50bp is still a "small probability"
Compared to the already clear and fully accounted for interest rate cuts themselves, the path of interest rate cuts is the focus of market competition, because after expectations are fully accounted for, it is difficult for 25bp to provide new catalysts ("How much interest rate cut expectations are included in current asset classes?"). Based on the view that the fundamentals are slowing down but not a deep recession, we maintain the benchmark path view of "can cut interest rates, but not a lot". A 50bp interest rate cut is still "unlikely" at present, unless the non farm payroll data is significantly lower than expected in the future. In this speech, Powell did not provide a clear path, stating that the pace of interest rate cuts depends on incoming data, evolving outlook, and balance of risks. However, Powell also stated that he does not believe that the rise in unemployment rate is the result of an elevated layoff, and believes that it is mainly due to a substantial increase in the supply of workers and a slowdown in recruitment from the previous fractional space of hiring, without excessive concern.
Since the beginning of this year, the expectation of interest rate cuts has fluctuated significantly multiple times. For example, two weeks ago, when the market fell sharply, the market expected a 50 basis point interest rate cut or even an emergency interest rate cut; Two months ago, influenced by the "Trump deal" and concerns about reinflation, it was expected to cut interest rates up to two times this year; Three months ago, due to the resilience of economic data and the expected start of the global investment cycle, copper prices continued to reach new highs, and the market even expected that interest rates should be raised instead of lowered; Six months ago at the beginning of the year, the market expected significant interest rate cuts of 6-8 times within the year. This also fully demonstrates that simple linear extrapolation at any point in time can be completely reversed.
Chart: When the market fell sharply 2 weeks ago, the market expected an emergency interest rate cut of 50bp in September or even a last-minute meeting.
Source: CME, Research Department of CICC
Chart: Two months ago, influenced by Trump and the reinflation trade, it is expected to cut interest rates up to two times this year
Source: CME, Research Department of CICC
The expected fluctuation increases the difficulty of asset allocation and requires an anchor point. Based on the new idea that interest rate cuts are aimed at reducing the financing costs of various departments and links to below the investment return rate, we estimate that the central level of 10-year US bonds is 4%, which corresponds to 4-5 overall interest rate cuts (about 100bp) during the current round of interest rate cuts by the Federal Reserve. This view has also been basically confirmed in the fluctuating expectations of interest rate cuts this year ("New Ideas for Measuring US Bond Interest Rates"). Of course, policy changes after the election, such as fiscal stimulus and inflation policies such as tariffs and immigration, may alter the future path.
Chart: Considering the inverted interest rate spread and financial risks, the Federal Reserve can cut interest rates 4-5 times (100bp) to achieve
Source: Bloomberg, Federal Reserve, Research Department of CICC
Chart: Expected fluctuations increase the difficulty of asset allocation, requiring an anchor point
Source: Bloomberg, Research Department of CICC
3、 Interest rate cuts and fundamentals: "Decline" does not mean that there is no need to cut interest rates much, and cutting interest rates in turn is enough to support growth
When it comes to the impact of interest rate cuts, the common "misconception" in the market is to use interest rate cuts as a starting point to deduce judgments that interest rate cuts often correspond to growth and market pressure. Little do they know that doing so is equivalent to reversing cause and effect. The correct approach is to first assess the economic cycle and then determine the magnitude and impact of interest rate cuts. After all, interest rate cuts were all aimed at addressing the growth issues at the time.
In addition, we do not recommend simply using "recession" to summarize the economic situation, as "recession" does not have a strict definition and the NBER's recognition of recession is very outdated. There is a fundamental difference between a simple slowdown and a recession. The former can quickly recover after the Federal Reserve adjusts financial conditions, which is reflected in assets. For example, the US stock market did not decline before and after the 1995 interest rate cut, and there was a phase of decline in the US stock market in 2019, but it quickly regained upward momentum. On the contrary, if it is a deep recession, a significant interest rate cut by the Federal Reserve may not be effective, and sometimes fiscal cooperation is needed, such as in the 2008 financial crisis ("Judgment Basis and Historical Experience of Recession"). So, excessive use of "recession" not only increases emotional and narrative pessimism, but also has no practical use. Instead, it can lead to excessive pessimism about risky assets and excessive optimism about safe haven assets.
When judging the economic position, overly discussing specific data or relying on so-called leading indicators is not an effective strategy. On the one hand, when there is a gap between slowing growth and monetary easing, data often fluctuates back and forth, and both pessimists and optimists can find their own reasons, unable to see the whole picture. For example, the manufacturing PMI has been consistently lower than expected in recent times, but the service PMI has also continued to improve; Employment data has slowed down, but real estate data has rebounded again after a 5-month hiatus.
Chart: When there is a mismatch between slowing growth and monetary easing, data often fluctuates back and forth between good and bad
Source: Haver, Research Department of CICC
On the other hand, the so-called leading indicators have very limited practical significance, as they cannot answer when the decline will occur after triggering, nor can they answer the degree of decline. For example, 1) Two consecutive quarters of negative GDP growth, as an empirical criterion for "technical recession," have already occurred in the first and second quarters of 2023. 2) The inverted yield curve of US Treasury bonds appeared in early 2022 and has been going on for over two years now, with the economy still maintaining resilience. 3) The Sahm Rule has just been triggered recently and is also the source of rising concerns about this round of recession. However, in Sam's latest interview [2], he also stated that this time may be different, such as the impact of immigration, whether it is necessary to consider the starting point of the rise in unemployment rate, rather than just the magnitude. 4) The Bank of Japan raised interest rates again last week, which according to market experience is a sign of recession. However, this is a posterior rule and lacks necessary correlation, basically equivalent to judging that the Fed's interest rate hikes often have a recession.
Chart: Sam's rule shows that the current rise in unemployment rate has triggered a recession condition
Source: Haver, Research Department of CICC
Chart: The Bank of Japan has raised interest rates again, which according to market experience is a sign of recession
Source: Bloomberg, Research Department of CICC
For the current environment, if recession refers to a slowdown in growth, we have no objections. The US economy is indeed in a slowdown channel, which is also the reason for the Federal Reserve's interest rate cuts, but the reverse also shows that there is no need to worry excessively; But if we are concerned about a deep recession, we believe it does not apply to the current situation. As discussed earlier, our starting point for judgment is not simply based on one or two data points or leading models, but more on the characteristics and peculiarities of the current US cycle: 1) The seemingly high interest rates actually have limited impact on the economy because the real interest rates are not high, and also because the investment returns in various links are not low. This is why at the beginning of the year, relying solely on the expectation of interest rate cuts to push down market interest rates can also promote the recovery of the real estate cycle. Recently, this effect has begun to manifest again, with the 30-year mortgage interest rate falling below the average rental return rate of 7% after following the 10-year US Treasury bond to 6.5%. After a 5-month hiatus, the sales of existing and new homes in the United States rebounded again in July. For the first time in five months, the sales of existing homes in the United States showed positive growth, and the leading new home sales also achieved a 10% month on month growth in July, exceeding market expectations (739000 households, expected 623000 households). At present, the financial condition index has once again fallen to a new low, and based on historical experience, it may gradually reflect the driving effect on interest rate sensitive sectors in the coming months.
Chart: The seemingly high interest rates actually have limited impact on the economy, because the real interest rates are not high, and also because the investment return rates in various links are not low
Source: Haver, Research Department of CICC
Chart: After the 30-year US mortgage interest rate fell from 7.2% in May to 6.5%, both new and existing home sales have recovered
Source: Bloomberg, Wind, Research Department of CICC
2) The misalignment of different links forms a hedge of mutual growth and loss. The resilience of service consumption is maintained because the consumption capacity of the residential sector is not sensitive to rising interest rates (90% of fixed rate mortgages), but will gradually slow down with the cooling of the job market. Meanwhile, real estate and investment, which have been at the bottom of the cycle for two years, are expected to moderately recover with interest rate cuts and declines.
Chart: The misalignment of different links forms a hedge of mutual growth and loss
Source: Research Department of China International Capital Corporation
Therefore, instead of dwelling on the word 'recession' itself, we should pay more attention to the depth of the economic downturn and the effectiveness of monetary easing. The Federal Reserve has also shown a positive attitude in responding to economic risks this time. Powell stated that there is ample room for monetary policy operations and he does not seek further cooling of the labor market. He used the phrase 'will do everything we can to support' to express support for maintaining a strong labor market, demonstrating a positive attitude towards policy response. In summary, growth pressure does not necessarily mean that the Federal Reserve does not need to cut interest rates significantly, and interest rate cuts can in turn support growth by adjusting financing costs.
4、 Trading strategy: moderate counter thinking and counter action; The denominator assets are 'fighting and retreating', and the numerator assets are gradually being laid out. The Chinese market needs its own policy cooperation
When judging the impact of assets and formulating trading strategies, just like judging the relationship between interest rate cuts and fundamentals, we should also start from the economic cycle. Interest rate cuts at different stages are not comparable, and may even be completely opposite. Therefore, excessive reliance on the "average law" of previous interest rate cut cycles has little reference value and may be misleading. From the perspective of the average pattern alone, before the interest rate cut, "denominator assets" such as US Treasury bonds, gold, Russell 2000, and growth stocks such as Hong Kong biotech tend to have greater elasticity, while "numerator assets" such as stocks, especially cyclical value, industrial metals, real estate chains, often face pressure. Otherwise, there would be no need to cut interest rates. After the interest rate cut, these assets gradually recover and outperform ("Interest Rate Trading Handbook"). However, this simple "average" rule is almost meaningless in practice, because the extent to which "molecular assets" intervene after a correction, as well as how long they switch after a rate cut, may vary greatly in different rate cut cycles.
Chart: Prior to the historical trend of interest rate cuts, denominator assets such as US Treasury bonds, gold, and growth sectors performed better; After the interest rate cut, molecular assets such as industrial metals, crude oil, and the US dollar are better
Source: Bloomberg, Research Department of CICC
Chart: However, the macro background of each interest rate cut is different, and the extent to which "molecular assets" intervene after a pullback and how long they switch after a rate cut are also different
Source: Bloomberg, Research Department of CICC
Therefore, the first step should be to determine whether the current situation is more similar to the soft landings of 1995 and 2019, or the deep recessions of 2001 and 2008. With this judgment, the extent of interest rate cuts and the impact on assets after interest rate cuts become clear. We tend to believe that 2019 is a more comparable benchmark scenario, which is why we recommend considering and doing the opposite when trading interest rate cuts. In the 2019 interest rate cut cycle, after the first interest rate cut, the long-term US bond interest rate bottomed out and gold peaked, while copper and US stocks gradually rebounded, rather than waiting until the end of the interest rate cut cycle.
This time may also be similar. The denominator asset is the main trading opportunity and has the greatest elasticity before the interest rate cut, and recent performance fully proves this point. However, due to the full inclusion of expectations and the limited magnitude of the interest rate cut, when the interest rate cut is realized, it may be necessary to gradually profit and withdraw, and should not be heavily increased. On the contrary, those molecular assets that benefit from interest rate cuts can choose the opportunity to moderately increase their holdings, as evidenced by the recent gradual rebound of copper and the gradual recovery of US real estate data.
Chart: We should first determine whether the economic fundamentals are similar to the soft landings of 1995 and 2019, or the deep recessions of 2001 and 2008
Source: Bloomberg, Research Department of CICC
Chart: After the first interest rate cut in 2019, the long-term US bond interest rate bottomed out, gold peaked, and copper and US stocks gradually rebounded, rather than waiting until the end of the interest rate cut cycle
Source: Bloomberg, Research Department of CICC
Specifically, the expected 10-year US Treasury bond interest rate of 3.8% is sufficient, and as the interest rate cut approaches, more attention can be paid to opportunities for short-term bonds and steepening curves; 2) The gold price of $2500 per ounce is also the central position we provide based on fundamental models, unless non fundamental geopolitical situations and central bank gold purchases increase again; 3) The US stock market has gone from the overvalued 'don't buy if you don't fall' to 'buy back if you fall too much'. 4) The real estate chain and industrial metals that benefit from interest rate cuts can gradually be monitored. We calculate based on the degree to which assets are included in the expectation of interest rate cuts' rushing ', and the interest rate futures are>; Copper>; US Treasury>; Gold>; How many types of assets are currently included in the expectation of interest rate cuts in the US stock market.
Chart: The expected 10-year US Treasury rate of 3.8% is well taken into account, and as the rate cut approaches, more attention can be paid to opportunities in short-term bonds and steepening curves
Source: Bloomberg, Research Department of CICC
Chart: Calculated based on the annual real interest rate of 1-1.5% and the range of 102-106 US dollars, the central price of gold may be around 2500 US dollars per ounce
Source: Bloomberg, Research Department of CICC
Chart: Calculated by the degree to which assets are included in the expectation of interest rate cuts "rush", interest rate futures>; Copper>; US Treasury>; Gold>; US stock market
Note: Data as of August 24, 2024
Source: Bloomberg, Research Department of CICC
For the Chinese market, the significance of the Federal Reserve's interest rate cut lies in providing operational space for internal policies, which is the core determining the trend of the A-share and Hong Kong stock markets, rather than the Fed's interest rate cut itself. Taking the 2019 interest rate cut cycle as an example, the significant rebound in A-shares and Hong Kong stocks occurred precisely from January to March when Powell announced the cessation of interest rate hikes at the beginning of 2019, and from July to September when interest rates were informally cut. Upon investigation, when Powell announced the cessation of interest rate hikes in early 2019, China also decided to lower reserve requirement ratios, creating a resonance both internally and externally. On the contrary, after April, the policy reintroduced the "monetary policy gate" and reversed the Federal Reserve's loose policy. Therefore, even if the Federal Reserve officially cuts interest rates from July to September, A-shares and Hong Kong stocks will maintain an overall volatile pattern, reflecting more the fundamentals of weak domestic recovery and tight policies, rather than the Federal Reserve's interest rate cuts. Overseas funds will also flow out during this period.
Therefore, it is not difficult to see that future interest rate cuts by the Federal Reserve provide a window for further easing of domestic policies. If the easing intensity can be stronger than that of the Federal Reserve at that time (the difference between China's real interest rate and natural interest rate is higher than that of the United States), it can provide greater boost to the market, especially the Hong Kong stock market; On the contrary, if the same degree of looseness is maintained but the intensity is flat or even weak, it will not change the overall volatile market structure. Based on this consideration and our assessment of the current environment and constraints, we believe that the impact of the Federal Reserve's interest rate cut on the Chinese market may be smaller than that of the election. In terms of interest rate cuts alone, the elasticity of Hong Kong stocks is greater than that of A-shares, while long-term assets such as semiconductors, automobiles (including new energy), media and entertainment, software, and biotechnology have greater elasticity.
Chart: For the Chinese market, the significance of the Federal Reserve's interest rate cuts lies in providing operational space for internal policies, which is the core determining the trend of the A-share and Hong Kong stock markets
Source: Bloomberg, Research Department of CICC
Chart: During the 2019 interest rate cut, overseas funds also flowed out
Source: Bloomberg, EPFR, Research Department of CICC
Chart: Semiconductor, automotive (including new energy) industry, media and entertainment, software, biotechnology and other growth sectors may have higher elasticity
Source: Wind, Research Department of CICC
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