CICC: Do not underestimate the timing and magnitude of the Fed rate cut
CICC believes that with the continuous improvement of US inflation and the simultaneous cooling of the economy, there is still ample room for interest rate cuts. US inflation may accelerate improvement, as long as there are no black swan events. The model predicts that CPI inflation will fall to the range of 2.5%-3% this year, and PCE will fall to the range of 2%-2.5%, with no observed risk of secondary inflation. The US economy is cooling simultaneously, so do not underestimate the timing and extent of the Fed's interest rate cuts
US Inflation May Accelerate Improvement
The US CPI for May will be released on June 12th (Wednesday). CICC's broad asset class model predicts a month-on-month nominal CPI of 0.07% for the US (consensus expectation 0.1%, previous value 0.31%, Chart 1), and a month-on-month core CPI of 0.27% (consensus expectation 0.3%, previous value 0.29%, Chart 2).
Chart 1: Nominal CPI month-on-month contribution breakdown and forecast
Source: Bloomberg, CICC Research Department
Chart 2: Core CPI month-on-month contribution breakdown and forecast
Source: Bloomberg, CICC Research Department
The significant decline in nominal CPI month-on-month reflects the lack of fundamental support for previous commodity price increases, with a noticeable adjustment in gasoline prices (Chart 3).
Chart 3: Weakness in Gasoline Prices
Source: Bloomberg, CICC Research Department
The slight decline in core CPI month-on-month reflects the statistical lag effect of the market on rent inflation (Chart 4), the recovery of labor market supply (Chart 5), and the balanced supply and demand trends of core goods (Chart 6).
Chart 4: Model shows rent inflation may continue to weaken
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Chart 7: ISM Chicago PMI is approaching recession levels
Data source: Bloomberg, CICC Research Department
This Friday, the May non-farm payroll data will be released. Bloomberg unanimously expects an increase of 185,000 non-farm payrolls, significantly lower than the 315,000 new jobs added in March (Chart 8).
Chart 8: Continued slowdown in US non-farm payroll growth
Data source: Bloomberg, CICC Research Department
We believe that the strong US economy in the first quarter may be related to abnormal seasonality after the epidemic, and the statistical data overestimated the economic momentum. US growth may still be in a downward trend and has not yet begun to recover, for the following reasons: US bond interest rates are too high, suppressing economic growth (Chart 9).
Chart 9: High US bond interest rates suppress economic growth
Data source: Wind, CICC Research Department
The marginal support of fiscal policy for the economy is weakening (Chart 10), and US residents' excess savings have been depleted (Chart 11). We recommend not underestimating the non-linear aspects of the economic downturn process.
Chart 10: Weakening fiscal support for the US economy
Data source: Bloomberg, CICC Research Department
Chart 11: The San Francisco Fed estimates that US household excess savings were depleted in March
![] Source: Federal Reserve, CICC Research Department
Considering the continuous improvement in inflation and the increased financial environment risks, it is recommended not to underestimate the timing and extent of the Federal Reserve's interest rate cuts. The futures market only prices in a 57% probability of a rate cut in September and a 19% probability in July. The market's pricing of rate cuts is cautious, leaving sufficient room for rate cut trades to perform well.
Embracing the wave of rate cuts overseas, Europe and Canada lead the way in rate cuts
Inflation improvement is not only happening in the United States. Since the end of last year, Germany's CPI has dropped by 150 basis points year-on-year, the UK by 110 basis points, and Canada by 70 basis points. The inflation rates in Germany and France have returned to around 2% (Chart 12).
Chart 12: Year-on-year central downward movement of CPI in various countries, improving inflation
Source: Wind, CICC Research Department
These countries are experiencing faster inflation improvement than the United States, reflecting weaker economies, also related to the statistical agencies' measurement methods for OER rent inflation. We expect significant inflation improvement overseas, creating conditions for central banks to shift towards rate cuts. The Swiss National Bank already cut rates in March this year. The Bank of Canada announced its latest interest rate decision this Wednesday, lowering the benchmark rate by 25 basis points to 4.75% and the bank rate from 5.25% to 5%, becoming the first central bank among G7 countries to take rate cut action [1]. The main reason is that the country's inflation slowdown has been ongoing for several months, while labor market activity has significantly cooled, coupled with weak economic growth in the first quarter with only 1.7% growth, significantly below expectations.
Meanwhile, the market generally expects the European Central Bank to cut rates for the first time since 2019 this Thursday, mainly due to fundamental pressures. Although the Eurozone's GDP grew by 0.3% in the first quarter, better than market expectations, Bloomberg shows that the market expects the full-year growth to be only 0.7%, indicating weak economic growth. The EU's year-on-year CPI rose slightly in May to 2.6%, but is already close to the European Central Bank's 2% target. Therefore, the market widely expects the European Central Bank to cut rates by 25 basis points, lowering the deposit rate from last year's record high of 4% to 3.75% [2].
Actively positioning for rate cut trades, increasing allocation to US bonds and gold
We predict that successive rate cuts by central banks overseas will create opportunities for global asset classes. Based on historical cycle experience, US bonds and gold tend to perform well six months after the Federal Reserve starts cutting rates (Chart 13) Chart 13: In the 6 months after the start of the rate cut cycle, US Treasuries and gold are dominant
Source: Federal Reserve, CICC Research Department
US Treasuries had high single-digit performance before the rate cut cycle began (Chart 14).
Chart 14: US Treasuries had the highest win rate from the end of the Fed rate hike to the beginning of the rate cut cycle
Source: Wind, CICC Research Department
However, in this cycle, US Treasuries only had a return of 1.8%, with potential for a rebound. Using the "interest rate expectations + term premium" analysis framework, the equilibrium price of the 10-year US Treasury yield is around 3.5%. Currently, the US Treasury yield is still at 4.3%, with sufficient room for downward movement. Gold has performed well in the past 2 years, with a cumulative return of 13% from 2024 to date, leading among global asset classes (Chart 15).
Chart 15: Ranking of global asset class returns from 2024 to date (as of 2024/6/5)
Source: Bloomberg, CICC Research Department
We believe that gold has not exhausted its upside potential after the start of the rate cut cycle, and the uptrend is not over yet. This is because the investment logic of gold has changed. The rise in gold over the past 2 years was mainly supported by its monetary properties, reflecting the decline in US dollar credit, but financial properties are still suppressing gold performance (Chart 16, "New Trends and Opportunities in Gold").
Chart 16: Decomposition of the contribution of the CICC four-factor model to the increase in gold prices
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Chart 17: Global major exchange copper inventory levels are not relatively low compared to previous years
Source: iFinD, CICC Research Department
If the global economy cools down too quickly, it may trigger a high-level adjustment in these assets' prices. Therefore, we recommend cautiously going long on overseas stocks and avoiding copper, oil, and other commodity assets. The progress of European inflation is faster than that of the United States, which may lead to pressure on the euro and limit the downward movement of the US dollar.
Authors: Li Zhao (SAC License No.: S0080523050001), Yang Xiaoqing (SAC License No.: S0080523040004), Qu Botao (SAC License No.: S0080123080031), Source: CICC Insight, Original Title: "CICC: Positioning Against Inflation, Embracing Interest Rate Cuts"