The Federal Reserve's interest rate decision to cut rates by 50 basis points, lowering the target range for the federal funds rate to 4.75%-5%, marks the first rate cut since the rate hike cycle began in March 2022.

Why did the Fed decide to cut rates?

What will be the pace and magnitude of future rate cuts?

In the current situation, where will global asset classes go?

This article reviews the price trends of major asset classes during the six rate cut cycles of the Federal Reserve since 1995, providing a reference for asset allocation during the new round of the Fed's rate cut cycle.

I.

Reason: With the decline in U.S. inflation, cooling labor market, and slowing economic growth momentum, the Fed adopts a preemptive rate cut.

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Based on the purpose of rate cuts, the Fed's rate cuts can be divided into two categories: one is preemptive rate cuts, which are implemented when the economy shows signs of slowing down to prevent the risk of economic recession; the other is remedial rate cuts, which are taken when the economy falls into recession or encounters a major crisis to provide emergency relief.

This rate cut is more inclined towards preemptive rate cuts.

Currently, the growth momentum of the U.S. economy is slowing down, but there is still some distance from a substantial recession.

High inflationary pressures in the U.S. have eased, and the labor market is cooling.

The August CPI grew by 2.5% year-on-year, falling for five consecutive months and reaching the lowest growth rate since March 2021.

The seasonally adjusted increase in non-farm employment in August was 142,000 people, lower than the expected 160,000; the unemployment rate rose to 4.2%, up 0.8 percentage points from the low of 3.4% since the pandemic.

The growth momentum of the U.S. economy is slowing down, but there are no obvious signs of recession yet, with the manufacturing industry cooling rapidly, but the service industry still maintaining moderate expansion.

The Fed has revised down its forecast for U.S. GDP growth in 2024 from 2.1% at the June meeting to 2%.

The U.S. August ISM manufacturing PMI was 47.2%, in the contraction range for five consecutive months; but the service industry PMI rose to 51.5%, with employment, new orders, and business activity sub-indices all in the expansion range.

It is expected that the U.S. economy will still maintain resilience within the year, with increasing downward pressure on the economy in 2025.

The better performance of the service industry, coupled with the Fed's loose monetary policy to offset, will support the U.S. economy to maintain resilience within the year.

However, as employment slows down, the excess savings of the household sector are exhausted, and the growth momentum of the service industry marginally falls back, it is expected that the risk of the U.S. economy going downhill will gradually increase in 2025.

II.

How to view the magnitude and subsequent rhythm of this rate cut?

Looking back at the previous six rounds of the Fed's rate cut cycles, the pace of preemptive rate cuts is slower, the decline is smaller, and the duration is shorter, while the pace of remedial rate cuts is faster, the decline is larger, and the duration is longer.

Looking at the magnitude of the rate cut, this 50bp rate cut is slightly more than expected, reflecting the Fed's greater confidence in achieving the inflation target and increasing support for the employment target.

First, referring to the pace of the previous rounds of preemptive rate cuts, the Fed's first rate cut will not be too drastic, starting with 25bp, and this 50bp rate cut is slightly more than expected.

Second, the Fed's confidence in achieving the inflation target has increased, and the constraints on rate cuts due to inflation have weakened.

The FOMC has revised down the U.S. 2024 PCE inflation forecast to 2.3%, from the June meeting forecast of 2.6%.

Third, the risk in the labor market has increased, and the FOMC has revised up the unemployment rate forecast at the end of the year from 4.0% to 4.4%.

Looking at the rhythm of rate cuts, it is expected that there will be two more rate cuts in November and December, with a single cut of 25bp.

The dot plot shows that the Fed will cut rates by a total of 100bp in 2024, that is, after the 50bp cut in September, there will be a total of 50bp of rate cuts in the following two meetings.

Before there is clear evidence that the U.S. economy has entered a substantial recession, the Fed does not need to cut rates aggressively continuously.

III.

Learning from history: The impact of Fed rate cuts on global asset prices (I) Review: The trend of global asset prices in previous Fed rate cuts This article reviews the performance of global asset prices during the five rounds of the Fed's rate cut cycles since 1995.

Considering that the liquidity crisis caused by the 2020 pandemic impact led to a general decline in global asset prices, the rate cut cycle of 2020 is not included.

Overall, U.S. Treasury bonds and gold have a higher winning rate, the stock market falls in the remedial rate cut cycle, and the dollar is under pressure.

Due to the difference in the magnitude of preemptive and remedial rate cuts, the average increase in gold and U.S. Treasury bonds during the preemptive rate cut period is smaller than that during the remedial rate cut.

Specifically: First, the trend of the stock market is determined by the economic fundamentals, and the correlation between the global major stock markets and the U.S. stock market is relatively high.

During the preemptive rate cut cycle, the U.S. economy did not show obvious signs of recession, and the U.S. stock market rose; during the remedial rate cut cycle, the U.S. economy fell into recession, and the U.S. stock market fell.

Second, the performance of U.S. Treasury bonds is relatively strong, and bonds with short maturities and low risks are greatly boosted by rate cuts.

In the five rounds of rate cut cycles, U.S. Treasury bonds rose four times.

The trends of Chinese bonds, Japanese bonds, and European bonds are relatively independent and have a lower correlation with the Fed's monetary policy.

Third, the dollar is under short-term pressure, and the long-term trend is affected by factors such as the relative strength of the U.S. economy and global risk aversion sentiment.

The Fed's rate cut increases the depreciation pressure on the dollar; however, the exchange rate is also affected by various factors such as the relative strength of domestic and foreign economic fundamentals, international trade situation, liquidity, and risk aversion sentiment.

Therefore, within three months after the first rate cut, the trend of the dollar has risen and fallen overall.

The exchange rate trends of the yen, RMB, and euro are also relatively independent.

Fourth, gold has a higher winning rate, and during the remedial rate cut cycle, it is greatly boosted by rate cuts.

(II) How does this rate cut affect major asset classes?

For the stock market, the rate cut releases liquidity, which is good for the U.S. stock market.

However, due to the uncertainty of the U.S. election and the path of monetary policy, as well as the current high valuation level of the U.S. stock market, one should also be alert to the risk of a pullback in the U.S. stock market.

For bond assets, U.S. Treasury bonds have a higher certainty, and the downward slope is slowing down.

Currently, there are no obvious signs of recession in the U.S. economy, and the Fed's rate cut rhythm is relatively slow, and it is expected that the downward slope of U.S. Treasury bond yields will slow down.

For the foreign exchange market, the dollar is under pressure, but the resilient U.S. economy supports the dollar, and Japan's rate hike and global risk aversion sentiment may support the yen to rise.

For gold, there is a risk of a pullback in the short term, but it may still be in an uptrend in the medium to long term.

Gold's "front-running" trend is obvious, and there is a risk of a pullback when the good news is realized.

In the medium to long term, supported by factors such as global "de-dollarization" and intensifying geopolitical conflicts, gold prices may still be in a long-term uptrend.

IV.

The impact of the Fed's rate cut on China's economy and major asset classes.

The Fed's rate cut opens up room for domestic monetary policy operations.

From the external environment, the Fed's rate cut is expected to reduce the constraints on further reserve requirement ratio cuts and rate cuts in China.

From the internal environment, the main contradiction of the current economy is the imbalance of supply and demand caused by insufficient domestic effective demand.

It is suggested that macro policies should continue to exert force and be more forceful, to cut the reserve requirement ratio and interest rates as needed, to boost residents' consumption and corporate investment demand.

The Fed's rate cut cycle is conducive to hedging the downward risks of the global economy and supporting the resilience of China's exports.

In terms of quantity, loose monetary policy eases the downward pressure on the U.S. economy.

If there are no major risk events, the U.S. economy will continue to be resilient, supporting China's exports.

In terms of price, the risk of the dollar going down is relatively low, and the impact of RMB appreciation on the competitiveness of China's export goods is limited.

The Fed's rate cut is slightly favorable for domestic stock market, bond market, and RMB 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 pressure on the dollar is conducive to the stability of the RMB exchange rate.

Risk warning: The U.S. economy falls back more than expected, and geopolitical conflicts evolve more than expected.