CCXI International: How will the Fed's interest rate cut and the start of an easing cycle impact the market?

According to the financial news app Zhitong Finance, on September 19th, Zhongchengxin International issued a statement, stating that on September 18th local time, the Federal Reserve of the United States concluded a two-day monetary policy meeting and announced a 50 basis point rate cut, lowering the federal funds rate target range to 4.75% to 5%. This is the first rate cut by the Fed since March 2020. Since June 2024, central banks around the world have successively announced rate cuts, making the monetary policy path of the Federal Reserve a focus of global markets. Due to the longer interval between this interest rate meeting and the July meeting, there was intense speculation in the market about the rate cut, leading to increased market volatility. Although there were signs of a rate cut after the release of the August non-farm payroll data, the 50 basis point rate cut exceeded the expectations of some institutions.

The latest dot plot from the Federal Reserve shows that there is still room for a 50 basis point rate cut within the year. After the rate cut announcement, the market experienced significant fluctuations. The Dow and S&P 500 indices both hit new highs during the session but later retreated, with all three major indices ending slightly lower. The US dollar and US bond yields initially fell and then rose, while gold rose to over $2600 per ounce, hitting a new high before retreating, and emerging market currencies also rose and fell.

Can the US economy achieve a soft landing?

Since the beginning of the year, the US economy has shown strong resilience, with second-quarter economic growth exceeding expectations supported by consumption. Due to the slower-than-expected decline in inflation, the Federal Reserve has made hawkish statements multiple times to delay rate cuts. Under the continued high interest rates, inflationary pressures in the US have gradually eased, with the August US Consumer Price Index (CPI) rising by 2.5% year-on-year, a decrease of 0.4 percentage points from July, marking the smallest increase since February 2021 and laying some groundwork for a Fed rate cut.

While inflation is decreasing, there are signs of weakness in the US labor market, shifting the Fed's policy focus from inflation resistance to job preservation. Signs such as rising unemployment rates, slowing job growth, and a balance between job vacancies and the number of unemployed individuals indicate a cooling US labor market, with the US unemployment rate rising from 3.7% at the beginning of the year to the current 4.2%. According to the Fed's latest economic forecasts, the median forecast for the year-end unemployment rate is 4.4%, higher than the 4.0% forecast in June; the economic growth forecast for 2024 is 2%, lower than the 2.1% in June; and the PCE inflation forecast for 2024 is 2.3%, further reduced from 2.6% in June. With the rise in unemployment rate, the Fed faces the need to rebalance between inflation, employment, economic pressures, and financial stability, aiming to maximize employment and achieve an "economic soft landing."

The market has not formed a consistent expectation for the trajectory of the US economy, with a significant rate cut potentially increasing economic vulnerability. Since July last year, the Federal Reserve has maintained the federal funds rate target range between 5.25% and 5.5%, the highest level in 23 years. Long-term high interest rates pose widespread risks to fiscal debt, the banking sector, and others. Against the backdrop of rising US debt risks and increasing partisan divisions, the lack of a consistent expectation for the trajectory of the US economy may exacerbate economic vulnerability with a significant rate cut, leading to increased market volatility. Overall, the uncertainty surrounding the US economy remains high, and a rate cut may not be able to reverse the downward economic trend in the short term. The future trajectory will depend mainly on economic data, Fed decisions, and the evolution of political and geopolitical risks What is the impact of the Fed's interest rate cut on China?

Historical experience shows that the start of an interest rate cut cycle in the United States is generally beneficial for global economic recovery and increased risk appetite. For China:

Firstly, the Fed's interest rate cut opens up space for further reserve requirement ratio cuts and interest rate cuts in China's monetary policy. Generally, after the Fed cuts interest rates, other major central banks may also take corresponding measures. Since August, the Bank of England, Bank of Canada, European Central Bank, and others have successively cut interest rates, signaling a global shift towards loose monetary policies. Although China's central bank has implemented policies such as changing the monetary policy anchor, reforming the LPR, and establishing a temporary interest rate corridor this year, the rate cuts have been insufficient. The central bank indicated in its August financial data interpretation that it will "introduce some incremental policy measures to further reduce the financing costs for enterprises and residents, maintain reasonable and adequate liquidity," and subsequently reduce the cost of funds for the real economy through reserve requirement ratio cuts, interest rate cuts, and other measures to promote economic recovery.

Secondly, a Fed interest rate cut usually leads to a decline in the US dollar index, potentially resulting in the appreciation of non-dollar currencies such as the Renminbi. Renminbi appreciation helps boost the performance of Renminbi assets and also provides support for further interest rate cuts and reserve requirement ratio cuts by the central bank. Since August, the USD to RMB exchange rate has started to fluctuate downward, reflecting expectations of a Fed interest rate cut in advance. The extent of further decline depends on the pace of Fed interest rate cuts and the performance of US economic data.

Thirdly, a Fed interest rate cut often leads to capital outflows from the US, which may temporarily drive up asset prices in China. Inflows of foreign capital into the capital market help improve liquidity in A-shares and the bond market, increase market trading activity, and may temporarily boost A-share prices. However, in the medium to long term, the performance of A-shares is more closely related to China's economic fundamentals. The impact of a Fed interest rate cut on A-shares may be limited.

Fourthly, the start of a Fed interest rate cut cycle helps boost the return of foreign capital inflows to China and improves capital projects, supporting economic recovery. Since April, the year-on-year growth rate of foreign direct investment in China has turned negative. With the Fed starting an interest rate cut cycle, global liquidity improvement may lead to a rebound in China's FDI, which is beneficial for further leveraging the positive role of foreign investment in industrial upgrading and economic growth. Additionally, global economic recovery also benefits China's export growth, partially offsetting the adverse impact of Renminbi appreciation on exports.

What is the impact on the US sovereign credit rating?

Currently, the Fed's policy path faces multiple challenges. While the US economy remains resilient, the pressure of economic downturn has significantly increased. The US debt level is at its highest among peer countries, and high interest rates have led to a significant increase in the US government's debt costs. Against the backdrop of the government lacking reliable fiscal consolidation measures, the sustainability of debt continues to decrease, and the deterioration of fiscal strength is eroding the credit foundation of the US dollar. At the same time, with the approaching election, the intensification of political divisions between the two parties in the US may have a negative impact on the continuity and effectiveness of policies. Recently, China Chengxin International will focus on the impact of interest rate cuts on the US sovereign credit, evaluate the economic, fiscal, and political risks of the US, and release rating actions in a timely manner.

In recent years, China Chengxin International has closely monitored changes in the US sovereign credit. In the adjustments to the US sovereign credit rating from 2020 to 2023, China Chengxin International's adjustment actions precede those of international rating agencies, demonstrating a relatively timely rating process On April 21, 2020, China Chengxin International downgraded the outlook for the United States from stable to negative while maintaining its AAAg sovereign credit rating. On March 16, 2023, China Chengxin International announced that the United States sovereign credit rating was placed on a watchlist for possible downgrade. On May 25, 2023, China Chengxin International downgraded the United States sovereign credit rating from AAAg to AA+g and continued to place it on a watchlist for possible downgrade