The United States enters an interest rate cut cycle, will China follow suit immediately?

1. The direction of the US interest rate cut cycle is set but the pace is unknown, the Fed is trying to balance inflation control and stable employment

In this speech by Powell, three important signals were released:

The US interest rate cut cycle may begin. "The time has come for policy to adjust".

The direction of interest rate cuts is set, but the pace and space still depend on the future US fundamentals. "The direction of travel is clear"; "the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks".

The Federal Reserve attaches great importance to the stability of the US job market. The Fed controls inflation this time without sacrificing domestic economic slowdown ("An important takeaway from recent experience is that anchored inflation expectations, reinforced by vigorous central bank actions, can facilitate disinflation without the need for slack"), which is also why the Fed implemented interest rate cuts despite the strong domestic employment situation.

Powell's speech has three indicative implications for global capital markets. First, the global manufacturing expansion driven by supply-demand mismatch has peaked; second, this is a major reversal in the direction of the US dollar cycle since 2022; third, this is a rare occurrence of interest rate cuts in the US under the backdrop of strong domestic employment.

2. For Chinese assets, the significance of the Fed's interest rate cut cycle lies in whether China's financial conditions can follow suit

With the Fed initiating an interest rate cut cycle, we will take the opportunity to explore its impact on global capital markets. For Chinese assets, the significance of Powell's speech lies in whether China's monetary policy can immediately see significant easing.

The market has already extensively discussed the fundamentals of Chinese assets. In other words, Chinese assets have been fairly priced based on the policies of "insufficient effective demand" and "stabilizing the fundamentals", and the market is also well aware that the prerequisite for the rebound of Chinese risk assets is the relaxation of financial conditions.

Recently, there has been a popular narrative in the market that after the US monetary easing, China may immediately follow suit with monetary easing. If the easing is significant enough and financial conditions open up accordingly, then the market can be more optimistic about Chinese risk assets.

Therefore, we need to explore a question: does the opening of the Fed's interest rate cut channel mean that the People's Bank of China will immediately follow with significant easing in monetary policy?

Three, we need to re-evaluate the Chinese currency orientation under the current US interest rate cut cycle

To answer the question of Chinese currency orientation under the US interest rate cut cycle, let's first look at three interesting patterns:

First, the linkage between the Chinese and US currencies is not as high as the market expected. In 2006-2007, 2010-2011, 2014-2015, and 2022-2023, there were typical instances of "reverse" movements in the Chinese and US currencies. This indicates that China's currency orientation as a major economy does not completely follow the US, but is more based on domestic considerations.

Second, although the space for interest rate cuts has opened up, it does not mean that the US will quickly adopt a very loose pace in the future. The 4.3% unemployment rate in July is not particularly high historically. Considering that the July unemployment rate still includes the impact of hurricanes, the current US service industry employment, service consumption, and service industry sentiment have not shown obvious signs of weakness. Therefore, this is a rate cut initiated by the US economy's relative strength. As Powell said, the Fed's control of inflation this time is "not at the expense of a slowing domestic economy." The relatively strong fundamentals of the US job market may imply that the pace of interest rate cuts in the US for the rest of the year will not be fast.

Third, the Renminbi (RMB) is indeed a factor that the central bank needs to consider, but not the only factor. Since the reversal of carry trade in August, the USD to RMB exchange rate has dropped from 7.2 to 7.14, and at certain times even touched 7.12. If the slow pace of interest rate cuts by the Chinese central bank in the second half of last year was due to constraints from the exchange rate, then with the RMB strengthening since August this year and the USD weakening under the expectation of US interest rate cuts, the Chinese central bank should be actively easing during this window. However, the reality is not so. The central bank has recently sent out frequent signals, focusing on "the stability of the financial system" (mentioned by the central bank governor in an interview), and "curbing the systemic risks that may arise from the unilateral downward trend in long-term government bond yields due to herd behavior" (mentioned by Xu Zhong in an interview). Perhaps the recent focus of the Chinese central bank has shifted back to domestic issues.

In conclusion, the US opening up an interest rate cut cycle does not mean a rapid and substantial rate cut, and the Chinese central bank is paying attention to global currency trends but is currently more focused on resolving domestic financial risks. This means that we cannot infer that the Chinese central bank's monetary policy will immediately follow with a significant easing just because the Fed has initiated rate cuts. The progress in resolving domestic financial risks may be a key anchor for observing the central bank's recent operations.

Article authors: Zhou Junzhi S1440524020001, Wang Zexuan, Source: CSC Research Macro Team, Original Title: "Zhou Junzhi's View: US Interest Rate Cycle and Chinese Currency Orientation"