CMS: Will the Federal Reserve continue to cut interest rates starting in September?

According to the Wise Finance APP, CMS Securities released a research report stating that interest rate cuts may be one of the catalysts for the fading of the suction effect of US stocks. From the end of 2023 to February this year and June this year, during the strong resonance phase of the US dollar and US stocks, the suction effect of US stocks was strengthened, putting short-term pressure on non-US assets. Recently, the possibility of a rate cut by the Federal Reserve in September, coupled with the Bank of Japan's reversal of the yen depreciation trend by raising interest rates again, has increased market concerns about the slowdown of the US economy. As a result, the suction effect of US stocks has cooled down, increasing the focus on non-US assets. In addition, a series of internal changes such as the Third Plenary Session, the central bank's rate cut, and active fiscal policies have gradually improved the performance of domestic equities.

Events:

On July 31, 2024, local time, the Federal Reserve held a monetary policy meeting, maintaining the federal funds target rate in the range of 5.25%-5.50%, consistent with the pace of balance sheet reduction and the decision of the June meeting, that is, reducing holdings of USD 25 billion in US Treasuries and USD 35 billion in MBS per month, in line with market expectations.

Key points from CMS Securities:

The Federal Reserve maintains policy rates and balance sheet reduction speed, with a slight relaxation of the inflation target and an increase in employment weight. There are three incremental pieces of information in the FOMC statement: first, the assessment of employment has shifted from "strong" to "moderated" for the first time since the January FOMC meeting; second, the description of inflation has changed from "at elevated levels" to "to some extent at elevated levels," also for the first time since the January FOMC meeting; third, the return of dual risks. Since May 2022, the focus of the Federal Reserve's policy has been on fighting inflation - "the Committee is highly concerned about inflation risks," but this meeting marked a shift - "the Committee is highly concerned about the risks of the dual mandate."

Signals from Powell's speech and Q&A: Balancing inflation and employment risks, nearing a rate cut but final decision depends on data.

1) Economy: Still resilient. Economic activity continues to expand at a steady pace; consumer spending has slowed from last year's strong pace but remains solid; equipment and intellectual property investment have recovered from last year's slump, with real estate investment surging in Q1 and stagnating in Q2; the probability of a hard landing is low at present.

2) Employment: Labor market cooling slightly. Job growth in Q2 was slightly slower than in Q1, but still solid; the unemployment rate has risen slightly but remains at a low level; the labor market conditions have returned to pre-pandemic levels - strong but not overheated.

3) Inflation: Making significant progress, but confidence needs to be strengthened. Significant progress has been made in goods, non-housing services, and housing services in core PCE, with Q2 inflation data boosting our confidence, and more positive data will further strengthen this confidence.

4) Rate path: Timing for rate cuts gradually maturing, September may see the first rate cut but depends on data support. In response to questions, Powell stated that a rate cut in September is "under consideration," but the premise is that overall data, not just individual data, align with the Fed's expectations. The explanation for "no rate cut at this meeting" is that although the committee generally believes that the economy is nearing an appropriate time for a rate cut, it is not yet fully mature. The policy rate is expected to start decreasing from the current level under basic conditions. Additionally, Powell does not want to set a specific path or forward guidance for rate cuts, considering zero to multiple rate cuts based on economic conditions Market Reaction: Expectations of Rate Cuts Boost Risk Appetite, Major Asset Classes Rise. Various assets rose before the FOMC decision was announced, with asset gains expanding after the decision and Powell's speech. 2Y and 10Y US Treasury yields fell by 10.1BP and 10.6BP to 4.27% and 4.04% respectively; the US dollar index fell by 0.43% to 104.04; COMEX gold, WTI crude oil, and LME crude oil rose by 1.70%, 5.23%, and 2.99% respectively; the S&P 500, Nasdaq, and Dow Jones indexes rose by 1.58%, 2.64%, and 0.24% respectively. Market expectations for rate cuts slightly increased, with a 87.5% probability of a 25BP rate cut in September and a 66.4% probability in November.

"Data-Dependent" First Rate Cut, "Wait-and-See" for Subsequent Cuts. Despite Powell's efforts to maintain risk neutrality and data dependence, the market still interprets it as neutral to dovish, as there is a possibility of a rate cut at a specific time in September. According to Powell, if economic and employment data deteriorate in July-August or if inflation further declines, it could trigger a rate cut in September. Therefore, going forward, every confirmation of economic data strengthens rate cut expectations, while deviations in data (such as resilient inflation) may lead the market to readjust rate cut paths. In addition, Powell mentioned that there is currently only one quarter of positive inflation data. If a rate cut lands in September, the Fed may reserve a quarter for a "wait-and-see" approach, as consecutive rate cuts are relatively stringent and require observation.

Why is a Rate Cut Before the Election Possible? The bank has expressed the view in reports that a rate cut before the election may be difficult, mainly because Biden's approval rating reflects voters' attitudes towards inflation. In Q3 2021, US inflation began to rise, and Biden's support rate plummeted; in June 2022, Biden's support rate hit its lowest level before the first debate in June this year, corresponding to the peak of this round of US CPI year-on-year; in Q4 last year, Biden's support rate fell below 40% again, which is related to the premature end of rate hikes despite ongoing high inflation. Furthermore, if Biden still has a chance of winning, a rate cut before the election will inevitably be unfavorable to his prospects and may be obstructed. However, the situation changed after the first debate, especially after Biden withdrew. Inflation is no longer linked to the candidate's prospects, allowing the Fed to push forward with monetary policy decisions more independently.

Rate Cuts Could be One of the Catalysts for the Ebbing Siphon Effect in US Stocks. From the end of 2023 to February this year and in June, when the US dollar and US stocks resonated strongly, the siphon effect of US stocks was strengthened, putting short-term pressure on non-US assets. With the possibility of a rate cut in September by the Fed, coupled with the Bank of Japan's reversal of yen depreciation, rate cut expectations have also fueled concerns about a slowdown in the US economy. The cooling of the siphon effect in US stocks has increased the focus on non-US assets. Additionally, a series of internal changes such as the Third Plenum, central bank rate cuts, and proactive fiscal policies have gradually improved domestic equity performance.

It is worth noting that the bank previously pointed out that the RMB exchange rate is highly likely to fluctuate in the "7.0-7.3" range; and defined domestic interest rate bonds and state-owned equity assets with high dividends as "autonomous controllable assets" (not influenced by external factors and foreign capital) Obviously, if the Fed continues to cut interest rates, internal factors gradually become positive, and domestic risk appetite continues to rise, then such assets will be in a continuous adjustment phase; but if the sustainability of the Fed's interest rate cuts and the uncertainty of internal changes persist, then "self-controllable assets" still have allocation value.

Risk Warning: U.S. economic performance exceeds expectations, Fed monetary policy exceeds expectations