Core Viewpoints
On August 23rd, Powell delivered a speech titled "Review and Outlook" at the JACKSON HOLE conference. According to the prepared remarks, a Federal Reserve rate cut in September is almost a "done deal." Powell clearly stated that "the time for policy adjustment has come, but the specific pace still needs to be determined based on future data and taken on a case-by-case basis."
The current core disagreement lies in the magnitude of the first rate cut (25BP or 50BP). By comparing the history of the last three times the Fed started an easing cycle with a 50BP rate cut, the current macroeconomic environment in the United States is most similar to that of January 2001. However, the current pullback in the U.S. stock market and the decline in the ISM manufacturing PMI are both significantly lower than at that time. Unless future data anomalies or external risk shocks (such as geopolitical factors) cause the U.S. stock market to experience another significant correction, the necessity for a 50BP rate cut in September is weak. We believe that the Fed is more likely to start this rate-cutting cycle in September with a 25BP cut.
For the whole year, it is expected that the room for rate cuts is 50BP or 75BP (the Fed will decide on the pace of rate cuts based on the resilience of economic data, either cutting rates incrementally or on a quarterly basis).
>> The September rate cut is almost a "done deal," and the pace still needs to be determined on a case-by-case basis
According to Powell's prepared remarks, a Federal Reserve rate cut in September is almost a "done deal." Powell clearly stated that "the time for policy adjustment has come, but the specific pace still needs to be determined based on future data and taken on a case-by-case basis."
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Firstly, he pointed out that the balance of the Fed's dual mandate has changed, with "reduced upward risks to inflation and increased downward risks to employment" implying that future policy decisions will focus more on the job market rather than inflation. Secondly, Powell stated that "the Fed is confident that inflation will steadily fall back to 2%," which is also a necessary condition for rate cuts that the Fed has mentioned several times before and has now been triggered. Thirdly, Powell believes that "the recent rise in unemployment is the result of both an increase in labor supply and a marginal weakening of hiring demand, and the Fed does not want the job market to weaken further," which also implies that the current unemployment rate has triggered the Fed's conditions for a rate cut.
>> Reviewing this round of "great inflation," inflation expectations are the challenge the Fed faces in continuing the path to lower inflation
Powell also reviewed and summarized this round of "great inflation," which to some extent also signifies a phased victory in this round of fighting inflation.
On one hand, the economic supply and demand distortion caused by public health events and the severe impact on the energy market are the core factors of high inflation, and the reversal of the above factors ultimately led to the decline in inflation. On the other hand, the loss of control over inflation expectations has also become an amplifier of this round of "great inflation," and the stability of U.S. residents' inflation expectations since the 21st century has not been tested by persistent high inflation. Whether future inflation expectations can continue to be anchored at a low level remains unknown. This argument also explains to some extent that inflation expectations are the challenge the Fed faces in continuing the path to lower inflation.If the US stock market does not fall in disorder, we believe there is a high probability that the Fed will start this round of the interest rate cut cycle with a 25BP cut in September. Considering recent inflation and employment data, it is almost certain that the Fed will cut interest rates in September, with the core disagreement lying in the magnitude of the first cut. By comparing the history of the Fed's last three easing cycles that began with a 50BP rate cut, we believe the probability of a 25BP cut in September is higher.
The most recent instance: In March 2020, under the disturbance of recession expectations due to public health events, the Dow and the Nasdaq retreated 12.3% and 10.7% respectively from their highs in February 2020. Coupled with the expectation of weakening fundamentals, the Fed made an emergency rate cut of 50BP on March 3, and then significantly reduced rates to zero at the interest rate meeting later that month.
The second most recent instance: In September 2007, the overall US fundamentals had not yet shown obvious risks, with the unemployment rate stable at 4.7% (below the neutral rate of 4.9% at that time), and the ISM manufacturing PMI reading of 51 was still above the boom-bust line. However, the cracks in the real estate market had become apparent, with the year-on-year growth rate of housing prices falling for nine consecutive months to around -5%, and the growth rate of new housing starts falling to -31%. Out of concern for the real estate market, the Fed cut rates by 50BP at the interest rate meeting that month.
The third most recent instance: In January 2001, the overall performance of US household data was still acceptable, with the previous month's unemployment rate at 3.9% (below the neutral rate of 5.2% at that time), and the growth rate of household consumption was still at 3.7%; the CPI growth rate was 3.4%, indicating a certain inflationary pressure. However, the pressure on the corporate side was relatively larger, with the ISM manufacturing PMI already falling to 43.9. US stock prices also experienced a significant correction, with the Nasdaq retreating nearly 30% overall in October and November 2000, stabilizing in December but ending the month with a 3.49% plunge on the 29th. Coupled with high-frequency data during holidays like Christmas not meeting expectations, out of concern for further market declines, the Fed ultimately initiated an emergency rate cut of 50BP on January 3, 2001, the first trading day of the year.
Overall, we believe that the current US macro environment is most similar to that of January 2001, but the current US stock market correction and the decline in ISM manufacturing PMI are both significantly lower than at that time. Unless future significant data disturbances or external risk shocks (such as geopolitical issues) cause the US stock market to experience another significant correction, the necessity for a 50BP rate cut in September is weak. We believe the probability of the Fed starting this round of the rate cut cycle with a 25BP cut in September is higher. For the year as a whole, we expect the interest rate cut space to be 50BP or 75BP (the Fed will make decisions based on the resilience of economic data, deciding whether to cut rates gradually or quarterly).
Regarding the future trend of various major asset classes, after Powell's speech further confirmed the interest rate cut in September, market risk appetite has been boosted. US stocks rose overall that night, the 10-year US Treasury yield slightly fell to 3.8%, and the US dollar index fell to 100.6.
In terms of the US dollar, since the US non-farm data on August 2 was significantly lower than expected, causing market turbulence and driving interest rate cut expectations to ferment. The US dollar index has been in a downward range, recently falling back to around 101, which is in line with the characteristics of the expected fermentation phase before the interest rate cut. In the future, we believe the US dollar index may gradually bottom out and rebound, and it is difficult for the index to break below 100. On the one hand, the interest rate cut is expected to help stabilize the fundamentals, and on the other hand, the market's current pricing of a 100BP interest rate cut within the year may still have room for retreat.
For US Treasuries, considering that the pricing of the interest rate cut space within the year has been relatively full, and whether it is Trump or Harris's policy in 2025, it may increase the reflationary pressure in the US and constrain the space of this round of interest rate cuts. We believe it is difficult for the 10-year US Treasury yield to fall significantly further and may still fluctuate widely around 4%.In the gold sector, the recent weak US dollar has directly benefited gold, but there is an increase in resistance to further short-term upward movement. In the medium to long term, global geopolitical instability and US reflationary pressures (especially the possibility of Trump intervening in monetary policy in the context of reflation) will continue to favor the long-term trend of gold.
In terms of US stocks, it is expected that they will continue to maintain a high level of volatility. After the recent sharp drop in US stocks, followed by a rapid rebound, the structural vulnerabilities such as high valuations and the divergence between large and small-cap stocks still exist. Future geopolitical events and AI industry dynamics may continue to keep US stocks volatile.
**Risk Warnings:**
- Geopolitical risks leading to unexpectedly worse inflation in the US; unexpected declines in US stocks.
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