Fed's Easing Cycle May Trigger Global Asset Shuffle

After a hiatus of 4 and a half years, the Federal Reserve has once again initiated an easing cycle. In the early morning of September 19th Beijing time, the Federal Reserve announced that it would lower the target range of the federal funds rate by 50 basis points, bringing it down to a level between 4.75% and 5%. This marks the first rate cut by the Federal Reserve since March 2020 and signifies the official shift of its monetary policy from a tightening cycle to an easing one.

Following the Federal Reserve's announcement of the rate cut, various global assets reacted swiftly, with non-US currencies generally rising, and the Chinese yuan performing particularly well. Several institutions believe that with the start of the Federal Reserve's easing cycle, there will be a major reshuffling of asset classes, and global capital flows, which had been concentrated in the United States two years ago, will now shift towards other regions. Emerging markets, represented by Chinese assets, are expected to welcome investment opportunities.

Further rate cuts may continue within the year. At the September FOMC meeting, the Federal Reserve decided to cut rates by 50 basis points, initiating this easing cycle, a reduction that exceeded the rate cuts made by other major central banks. Federal Reserve Chairman Jerome Powell stated that the Federal Reserve is committed to maintaining strong economic growth rather than worrying about an impending recession. He added that the Federal Reserve is confident in allowing inflation to sustainably fall back to the 2% target, enabling a robust start to the easing cycle.

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In response, several domestic and foreign institutions believe that the Federal Reserve's 50 basis point rate cut this time signifies the beginning of the normalization of US interest rate policy, and they expect the pace of subsequent rate cuts by the Federal Reserve to be adjusted according to the economic environment.

"Currently, the Federal Reserve's dot plot indicates that there will still be two rate cuts within the year, totaling 50 basis points. The market's pricing is slightly more aggressive, approaching three times. Since the current interest rates are still at a restrictive level, we consider such a forecast to be relatively neutral, that is, a rate cut path for a soft economic landing. Powell also emphasized that adjustments to the pace of rate cuts will still be made based on economic data, so it is necessary to continue tracking economic data," said He Si Yao, the QDII multi-asset investment manager at HSBC Jinxin Fund.

Li Zhan, Chief Economist of the Research Department at China Merchants Fund, stated that conservatively estimating, the Federal Reserve's total rate cut for the year 2024 is highly likely to be between 75 to 100 basis points. He believes that the probability of a 75 basis point cut for the year is relatively high. Since the key to this round of rate cuts lies in the labor market, the decline in the unemployment rate is more instructive for the Federal Reserve's subsequent rate cuts. From a long-term perspective, the rise in US unemployment rates in this cycle is mainly due to the increase in total employment driven by the recovery of labor force participation rates, hence the US economy has not yet shown signs of recession risk.

"The current Federal Reserve monetary policy framework focuses more on the unemployment rate. If the unemployment rate continues to rise further, especially if it breaks through the natural rate of unemployment set by the Congressional Budget Office (4.41%), then the pace of the Federal Reserve's rate cuts is expected to accelerate, and the magnitude will also increase. Otherwise, I am inclined to believe that the probability of the Federal Reserve cutting rates by 75 basis points this year is higher," Li Zhan said.

Tom Porcelli, Chief US Economist at PIMCO Fixed Income, stated that this rate cut marks another adjustment in US monetary policy to adapt to an environment of continued economic slowdown following the decline in inflation. Although the Federal Reserve has clearly indicated that it will promote easing policies for the remainder of this year, the persistently weak labor market and the knock-on effects of retail spending may pose challenges to a more moderate easing policy.

Central European Fund believes that considering the current state of the US economy, which overall maintains resilience with uneven departmental performance, a more substantial rate cut is beneficial for the gradual recovery of interest rate-sensitive sectors such as manufacturing and real estate in the United States, while income-sensitive sectors such as consumption and services are already in good condition. An earlier and more substantial rate cut implies that there may not be much room for subsequent rate cuts. Powell emphasized not to regard the 50 basis points as a new rhythm, which also means that, in the eyes of Federal Reserve officials, the current operation is considered a preemptive rate cut.Rebalancing of Major Asset Allocations

The Federal Reserve's latest interest rate cut will also trigger a series of chain reactions across various global assets. Following the announcement of the rate cut, global markets responded strongly, with non-US currencies generally rising, and the Chinese yuan performing particularly well. Industry insiders believe that as the Fed's interest rate cut cycle begins, changes will occur in the global allocation of major assets.

Xia Qing, Co-Head of Investment Strategy Group for Asia at Goldman Sachs Private Wealth Management, stated that the macroeconomic backdrop of the Fed's interest rate cut has a significant impact on the subsequent performance of major assets. During non-recessionary periods, interest rate cuts are beneficial for equity assets. Historically, within 12 months after the Fed's interest rate cuts, the average return on US stocks, while avoiding recession, is 19%. However, if a recession occurs, US stocks will decline.

Li Zhan believes that after the Fed's interest rate cut, the following situations are expected to occur. First, global capital, which had been concentrated in the United States two years ago, will shift towards Europe, Japan, and other developing countries. However, due to the possibility of further interest rate hikes in Japan, international hot money may continue to flow into Japan. Second, there is still uncertainty for the euro against the US dollar, especially as the European Central Bank's interest rate cut pace may be faster than that of the United States. The European Central Bank has indicated three interest rate cuts within the year; if the Fed ultimately cuts rates by more than 75 basis points, the euro may appreciate, which would be beneficial for the decline in import prices and stimulate European consumption. Third, the interest rate cut is expected to enhance the attractiveness of developing countries to international capital. Fourth, the Fed's interest rate cut will also stimulate demand for commodities, providing some support for commodity prices.

CE Fund stated that in general, during preemptive interest rate cuts, the further downward space for US Treasuries may be relatively limited, while US stocks and the US dollar often fluctuate and are relatively strong. Gold may face pressure to further rise. However, the market's consensus on this matter still needs further verification. The next interest rate meeting is in November, and the two employment reports and one inflation report before that will be key variables affecting the subsequent pace of the Fed's interest rate cuts.

In the view of Yang Ao, Chief Chinese Market Analyst at FXTM, there is still room for gold prices to continue to reach new highs. Among the many factors affecting gold prices, the US dollar plays a significant role, and geopolitical factors do not have a particularly obvious impact on gold prices. The trend of gold prices is generally negatively correlated with the US dollar and US Treasury yields. Yang Ao believes that there is still room for the US dollar and US Treasury yields to decline, and gold may continue to rise. If the US dollar index falls below 100 in the future, gold prices have the opportunity to challenge historical highs again.

Emerging Markets Welcome Investment Opportunities

Data from the International Institute of Finance (IIF) shows that within five months after the Fed began raising interest rates in March 2022, emerging markets experienced net outflows of investment portfolio funds for five consecutive months, totaling more than $39 billion, setting the longest record of consecutive net outflows of funds from emerging markets since 2005. Many institutions believe that as the Fed starts the interest rate cut cycle, emerging markets will welcome investment opportunities.

Li Zhan believes that the decline in US risk-free interest rates will drive global capital to flow out of the United States, benefiting the Asia-Pacific market and other emerging markets. "The Fed's interest rate cut decision has had a multifaceted impact on investment opportunities in emerging markets. According to the IMF's analysis, the Fed's interest rate cuts may support a further rebound in bond issuance by emerging economies, promoting their economic growth," said Li Zhan.

In the view of Zhu Chaoping, Global Market Strategist at J.P. Morgan Asset Management, the Fed's interest rate cuts may drive some funds towards the Asia-Pacific emerging markets and may also bring room for further policy easing in China. Currently, the valuation of Asia-Pacific stocks is far lower than that of the United States, which has a strong attraction for international capital. These factors will help repair the valuation of Chinese assets.Zheng Yu Chen, Deputy General Manager and Chief Investment Officer of Allianz Fund, believes that Chinese assets will benefit from the Federal Reserve's interest rate cut. After the Federal Reserve's interest rate cut is finalized, the interest rate differential between China and the United States is expected to narrow further, which also opens up more policy space for China's interest rates to decline. "Hong Kong stocks, especially high dividend stocks in Hong Kong stocks, which are more affected by overseas interest rates and funds, may respond more quickly and better to this interest rate cut," said Zheng Yu Chen.

Zhao Yao Ting, Global Market Strategist for Invesco Asia Pacific (excluding Japan), said that the Federal Reserve's initiation of an interest rate cut cycle will support non-US dollar assets, as this may lead to the US dollar starting to enter a cyclical weakening in the near future. In the long run, the decline in US Treasury yields will enhance the long-term appeal of Chinese assets.

Guangdong Kai Securities said in its latest research report that the Federal Reserve's interest rate cut is favorable for China's stock market, bond market, and the renminbi exchange rate. Global liquidity easing helps to provide incremental funds for China's stock market, the increase in China's monetary policy space will drive bond yields down, and the US dollar under pressure is conducive to the stability of the renminbi exchange rate.