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Wu Bin, researcher at the 21st Century Economic Research Institute

The global interest rate cut trend has once again gained strength, with more and more overseas central banks entering a cycle of interest rate cuts, which has become the mainstream trend of current monetary policy.

In the past month, due to the increasing inflationary pressure, the Russian Central Bank raised interest rates by 200 basis points to 18%, and the Bank of Japan raised interest rates by about 20 basis points under the pressure of yen depreciation. However, more central banks are on the way to lower interest rates, with the Bank of England starting its first rate cut and the Bank of Canada cutting interest rates by 25 basis points twice in a row. The Federal Reserve, the Bank of Korea, the Central Bank of Brazil, the Central Bank of Turkey, the Central Bank of Indonesia, and the Central Bank of South Africa are temporarily keeping their positions unchanged.

In 2023, the market expected that 2024 would be a "year of interest rate cuts" by global central banks, but the subsequent repeated anti-inflation process caused central banks' expectations for interest rate cuts to drop again and again. Now, as inflationary pressures have eased significantly and economic concerns have intensified, the possibility of a "year of interest rate cuts" by the Federal Reserve and other central banks has resurfaced. At the same time, economic concerns and the divergence of monetary policies between the United States and Japan have also caused huge shock waves in the global market.

Bank of England "hawkish rate cut"

After the Bank of Canada and the European Central Bank, another G7 central bank joined the interest rate cut trend. On August 1, the Bank of England announced a 25 basis point interest rate cut to 5.00%, in line with market expectations and the first interest rate cut since March 2020.

However, the Bank of England's Monetary Policy Committee (MPC) passed the interest rate decision with a vote of 5 to 4, with members Greene, Haskell, Mann and Peel voting to keep the interest rate unchanged, indicating that members still have different opinions on whether inflationary pressures have been sufficiently eased.

Therefore, this is actually a "hawkish rate cut." Bank of England Governor Bailey said in his monetary policy statement, "Inflation pressures have eased and we can lower interest rates, but we need to ensure that inflation remains low and be careful not to lower interest rates too quickly or too much."

Bailey stressed that the Monetary Policy Committee will continue to act cautiously, ensuring that inflation remains low and being careful not to cut interest rates too quickly or too much. The committee is not committed to a series of rapid interest rate cuts and will adopt a "meeting by meeting" approach to making interest rate decisions. Bank of England Deputy Governor Ramsden also said that even if interest rates are cut, the Bank of England can implement its plan to sell bonds in the coming year and continue quantitative tightening.

From the data point of view, the data released by the UK National Statistics Office showed that the UK's overall inflation rate has returned to the target of 2%, far below the 41-year high of 11.1% in October 2022. Specifically, the UK CPI rose 2% year-on-year in June, the same as in May, higher than the market expectation of 1.9%. Among them, the service industry inflation rate was 5.7%, the same as in May, but also higher than the expected 5.6%. Although the UK service industry inflation is still high, the rising unemployment rate and the decline in commodity prices may make the Bank of England more concerned about the long-term inflation and growth prospects.

As the impact of last year's sharp drop in energy prices fades, the Bank of England expects overall inflation to rise to 2.75% in the last quarter of this year, then fall back to the 2% target in early 2026, and then continue to slow down. The Bank of England claims that inflation risks will remain biased to the upside throughout the forecast period, and monetary policy needs to remain restrictive for a long enough time until the risk of inflation returning to the 2% target in the medium term dissipates further. On the economic level, the Bank of England has significantly raised its growth expectations, predicting that UK GDP will grow by 1.25% in 2024, much higher than the 0.5% forecast in May, reflecting stronger-than-expected growth in the first half of this year.

The Fed may cut interest rates further amid economic gloom

The most difficult stage of fighting inflation has passed. On July 31, the Federal Reserve kept the target interest rate range unchanged at 5.25%-5.50%. In the statement of the Federal Open Market Committee (FOMC), policymakers did not promise to cut interest rates in September. Although progress has been made in fighting inflation, they will not cut interest rates until they have more confidence in the decline of inflation.

The Fed did not make a written commitment to cut interest rates in September, but Fed Chairman Powell said at a press conference after the interest rate decision that a rate cut could happen as early as the September meeting. The overall view of the committee is that the economy is approaching a level suitable for rate cuts. The Fed believes that the risk of inflation has dropped significantly, while the risk of weaker employment is rising. The monetary policy stance has gradually shifted from focusing on controlling inflation to taking both inflation and employment into account. Powell said that as inflation cools, the Fed will be able to assess inflation and the job market more equally.

Although Powell denied considering a 50 basis point rate cut at the end of July, subsequent economic data showed that a 50 basis point rate cut was indeed possible. On August 1, data released by the Institute for Supply Management (ISM) showed that the US ISM Manufacturing PMI fell to 46.8 in July, far below the economists' forecast of 48.8. Among the sub-items, the output index fell from 48.5 to 45.9, and the employment index fell from 49.3 to 43.4, the worst since June 2020.

The slowdown in U.S. employment in July also exceeded expectations, with the unemployment rate rising to its highest level in nearly three years. Specifically, the seasonally adjusted non-farm payrolls in the United States in July were 114,000, the smallest increase since April 2024, far below the expected 175,000. The unemployment rate unexpectedly climbed to 4.3%, rising for four consecutive months.

After the Fed "stepped on schedule" and did nothing again at the end of July, the latest data and changes in market expectations have intensified people's concerns that the Fed is too slow to respond. After the COVID-19 pandemic, US inflation has risen sharply, but the Fed has been slow to raise interest rates, saying that high inflation is "temporary". Now the Fed may be too slow to respond again, and the economy may face the risk of recession. Other G10 central banks such as the Bank of Canada, the European Central Bank, and the Bank of England have already begun to cut interest rates. The Fed's monetary policy is once again facing questions about being "slow to the beat".

The possibility of a "rate cut year" has resurfaced. CME's Fed Watch tool shows that traders are betting on a more than 70% chance that the Fed will cut rates by 50 basis points at its September meeting. Citigroup and JPMorgan Chase both expect the Fed to cut rates by 50 basis points each in September and November, and by 25 basis points each time starting with the December meeting, meaning the Fed will need to cut rates by 125 basis points this year.

Bank of Japan moves forward with monetary policy normalization

As the Federal Reserve is about to enter a rate cut cycle, the Bank of Japan is further promoting monetary policy normalization, and the interest rate gap between the United States and Japan continues to narrow.

In early July, the USD/JPY exchange rate reached 161.95, and the yen hit its lowest level since 1986, sparking concerns that an overly weak yen might increase import costs and keep inflation high. Some government officials and members of Congress called on the Bank of Japan to tighten monetary policy to boost the yen.

On July 31, the Bank of Japan announced another interest rate hike, raising the short-term interest rate from 0 to 0.1% to 0.25%. At the same time, it finalized a balance sheet reduction plan to reduce the scale of government bond purchases from the current 6 trillion yen per month to 3 trillion yen by the first quarter of 2026.

The Bank of Japan had previously stressed the uncertainty of economic and inflation forecasts and was very cautious in pushing up interest rates. But in its latest decision, the Bank of Japan abandoned this argument and instead stated that "if the outlook for the economy and prices can be realized, it will continue to raise the policy interest rate."

Kazuo Momma, former director of the Bank of Japan, said that the Bank of Japan's major policy shift makes it very likely that another rate hike will be made in October, and it also increases the possibility of a rate hike every quarter. The Bank of Japan's policy response mechanism has now changed, which also means that there is a possibility of another rate hike in January next year.

In Kazuo Monma's view, the current basic position of the Bank of Japan seems to be that since the actual interest rate is very low, the central bank can continue to raise interest rates as long as the economy does not suffer a major shock. The current policy rate is 0.25%, which is far below the recent core inflation level of 2.6%.

Global markets plunged under the butterfly effect

The divergence in monetary policies between the central banks of the United States and Japan is flapping its wings. The yen has appreciated significantly and the interest rate gap between the United States and Japan has narrowed. As investors settle carry trades around the yen and coupled with factors such as concerns about the US economy, the foreign exchange and stock markets have fluctuated violently, ultimately triggering "Black Monday."

Recently, the Japanese stock market has suffered a series of sharp declines. On August 1, the Nikkei 225 Index fell by 2.49%, and on August 2, it fell by 5.81%. On August 5, the Nikkei 225 Index closed down more than 12%, erasing all gains since the beginning of the year. The Nikkei 225 Index's single-day drop of nearly 5,000 points set a record, surpassing the record of "Black Monday" in October 1987.

Other markets also fell. The Korean stock market's composite stock price index closed down more than 8% on the 5th. Major European stock indices opened with a collective drop of about 2%. U.S. futures and technology stocks also generally fell. Bitcoin once fell by more than 10%.

Peter Schiff, chief market strategist at Euro Pacific Asset Management, said the unwinding of the yen carry trade, which had long supported the global bull market by enabling cheap borrowing to be invested elsewhere, was causing turmoil in stock markets.

While the carry trade was initially triggered by the Bank of Japan’s rate hike, the sell-off has become intense over the past few days as concerns about global growth have added fuel to the fire. Fears of a recession have intensified after the release of U.S. July jobs data.

With a series of disappointing economic data, Goldman Sachs has raised the probability of a US recession next year from 15% to 25%. Meanwhile, global hedge funds are continuing to increase their bearish bets on stocks in their portfolios in the week ending August 1. The pace at which hedge funds bet on a decline in US stocks has exceeded the pace of increasing long positions for three consecutive weeks. Goldman Sachs pointed out that the ratio of hedge funds increasing long positions to short positions has approached 1:3.3.

At the same time, the U.S. Treasury market saw its biggest rally since the regional banking crisis broke out in March 2023. The 2-year Treasury yield, which is particularly sensitive to interest rate policy, plummeted by more than 50 basis points last week, and the 10-year Treasury yield, known as the "anchor of global asset pricing," fell by about 40 basis points last week.

Kathryn Kaminski, chief research strategist and portfolio manager at quantitative fund AlphaSimplex Group, said that given the sluggish stock market, investors are rushing to buy bonds before U.S. Treasury yields fall further, and the bond market seems to have room to continue to rise. "People want to lock in high interest rates, which has created a lot of buying pressure in the bond market, and there is also risk aversion. If the Fed cuts interest rates in the second half of the year, the 10-year U.S. Treasury yield may fall to close to 3%."