Since the interest rate cut is certain, let's increase the bet a little

Abstract

In anticipation in the global market, Federal Reserve Chairman Powell solemnly announced to the world that the interest rate cut cycle in the United States is about to begin. In a speech at Jackson Hole of less than 20 minutes, Powell not only mentioned "Time has come" - the interest rate cut is coming, but also hinted in various ways that the Fed's future main task is not only to avoid economic recession, but also to ensure a soft landing for the economy.

In his speech of several tens of minutes, Powell mentioned the "journey of the heart" of monetary policy operations in the past few years, and pointed out several important directions: First, the "cooling down" of the U.S. labor market is related to the increase in labor supply; second, stabilizing inflation expectations remains a top priority; third, the focus of the Fed's work is still to achieve a soft landing for the economy. Such remarks actually indicate that the Fed's interest rate cut may be preemptive, and the Fed hopes to achieve a new balance between preventing inflation and stabilizing growth.

Compared to Powell's speech, another set of important data released last week seems somewhat lackluster. According to the employment and wage data from the first quarter of 2024, the U.S. Bureau of Labor Statistics estimates that in the annual benchmark revision to be released in February 2025, the non-farm employment figure as of March 2024 will be revised downward by 818,000. It should be noted that even after these significant downward revisions, the labor market in the past year and the first quarter of 2024 still appear solid. This is consistent with the resilience of consumer spending.

After Powell's speech, there was not much change in the market's pricing of a rate cut in 2024. Currently, the market believes that the Fed will cut rates by 100 basis points within this year. This seems a bit challenging, as there are only three interest rate meetings within the year, and under the benchmark scenario, the probability of a 50 basis point rate cut is still the highest; if there is a 100 basis point rate cut, it means that there will be a rate cut at each of the three meetings in the future, with one meeting requiring a 50 basis point cut.

Of course, since the rate cut is certain, it is also a normal choice to take a bit more risk in the magnitude of the rate cut. In other words, at this time, the viewpoint is not important, but how to respond is more important. Faced with the surging rate cut trades, the U.S. dollar index also experienced a sharp decline, hitting a one-year low. At the same time, the stock market once again rejoiced, as if investors had completely forgotten about the global market turmoil in early August.

Main Text

In anticipation in the global market, Federal Reserve Chairman Powell solemnly announced to the world that the interest rate cut cycle in the United States is about to begin. At the annual Jackson Hole central bank symposium, Powell became the undisputed protagonist. In a speech of less than 20 minutes, Powell not only mentioned "Time has come" - the interest rate cut is coming, but also hinted in various ways that the Fed's future main task is not only to avoid economic recession, but also to ensure a soft landing for the economyThe focus of the market's attention is whether Powell will explicitly indicate a rate cut, but the suspense of whether or not to cut rates is actually not significant. In his speech lasting tens of minutes, Powell mentioned the "journey of the heart" of monetary policy operations in the past few years, which also largely indicated the difficulty of monetary policy operations. From the initial significant easing in response to the epidemic, to the initial inadequate response to high inflation, and to gradually suppressing inflation over the past year, Powell described the difficulties of the past few years, but also pointed out several important directions: First, the "cooling down" of the U.S. labor market is related to the increase in labor supply, and the rise in the unemployment rate is not due to large-scale layoffs by companies; Second, stabilizing inflation expectations remains a top priority, and only under the premise of stable inflation expectations can the Fed have the confidence to cut rates more and faster; Third, although many market participants are not optimistic about the U.S. avoiding a recession, the Fed's focus is still on achieving a soft landing for the economy. Such remarks actually indicate that the Fed's rate cut may be preemptive, and at the same time, the Fed hopes to achieve a new balance between preventing inflation and stabilizing growth.

Compared to Powell's speech, another set of important data released last week seems somewhat lackluster. However, regardless, the situation of the U.S. labor market is still worth investors' high attention. According to the Quarterly Census of Employment and Wages (QCEW) data for the first quarter of 2024, the U.S. Bureau of Labor Statistics (BLS) estimates that in the annual benchmark revision to be released in February 2025, the non-farm employment figure as of March 2024 will be revised downward by 818,000. This means that from April 2023 to March 2024, employment increased by 2.1 million (or 173,000 per month), instead of the previously estimated 2.9 million (or 242,000 per month). This downward revision is mainly driven by professional and business services, leisure and hospitality, and manufacturing. On the other hand, private education and health industries have seen significant upward revisions.

Many investors wonder if the downward revision of employment data will affect the unemployment rate. The answer is no - because the unemployment rate is calculated based on household surveys, while QCEW is based on surveys of interviewed institutions. At the same time, it should be noted that even after these significant downward revisions, the labor market in the past year and the first quarter of 2024 still appears solid. This is consistent with the resilience of consumer spending.

For the Fed, as Powell mentioned, its concern about the labor market stems from the soft job growth since the second quarter of this year and the deterioration of other indicators (such as job vacancy rates). In other words, this data revision mainly adjusts last year's data, and the Fed will not panic because of the downward revision of the labor market last year.

Following Powell's speech, there was not a significant change in the market's pricing of a rate cut in 2024. Currently, the market believes that the Fed will cut rates by 100 basis points within the year. This seems a bit challenging, as there are only three interest rate meetings within the year, and under the benchmark scenario, the probability of a 50 basis point rate cut is still the highest; if there is a 100 basis point rate cut, it means that there will be a rate cut at each of the next three meetings, with one meeting requiring a 50 basis point cut

Of course, since the rate cut is certain, it is a normal choice to increase the bet on the rate cut. In other words, at this time, the viewpoint is not important, but how to respond is more important. Faced with the surging rate cut trading, the US dollar index also experienced a sharp decline, hitting a one-year low. The euro exchange rate climbed to 1.11, and the renminbi exchange rate rose to 7.11, indicating a significant unwinding of positions in the foreign exchange market. At the same time, the stock market is once again in a frenzy, as if investors have completely forgotten about the global market turmoil in early August. The Hang Seng Index has recently shown some signs of stabilization, coupled with the upcoming rate cut in September, the market seems to have a positive outlook on the Hang Seng Index.

Author: Zhou Hao (SAC License No.: S0880123060019), Sun Yingchao, Source: Guojun Overseas Macro Research, Original Title: "Since the rate cut is certain, let's increase the bet a little more"