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At the Jackson Hole Global Central Bank Annual Meeting, Federal Reserve Chairman Powell made it clear that the interest rate will be cut at the September meeting and said that "the time for policy adjustment has come."

Starting from March 17, 2022, the Federal Reserve started to raise interest rates to fight the high inflation after the epidemic, with a cumulative rate hike of more than 500 basis points (BP). Today, the core PCE, the inflation indicator most favored by the Federal Reserve, has dropped to 2.6% year-on-year (close to the 2% target), and the unemployment rate has risen from 3.7% to 4.3% since the beginning of the year, which once triggered recession concerns. Goldman Sachs believes that the Federal Reserve will cut interest rates by 25BP three times in a row at the September, November and December meetings. If the August employment report is weaker than that in July, the interest rate may be cut by 50BP in September.

This shift has far-reaching implications for the stock, bond and foreign exchange markets. The U.S. dollar index accelerated its decline in August, falling below the 101 mark after the Jackson Hole meeting, after hitting a new high for the year on June 28; Asian currencies, including the RMB, may be boosted. In the absence of a recession, interest rate cuts are also good for the stock market. It is expected that U.S. stocks will continue to hit new highs, and U.S. bonds may also be boosted by interest rate cuts. From 1989 to the present, in the six interest rate cut cycles of the Federal Reserve (1989, 1995, 1998, 2001, 2007, and 2019), in terms of the average performance of stocks and bonds in the first year after the interest rate cut, the Nasdaq index rose by 9.7%, the S&P 500 index rose by 5.8%, the total return of U.S. Treasury bonds was 6.2%, and the total return of U.S. composite bonds was 5.7%.

Powell sends clear signal of rate cut

Powell was no longer ambiguous this time, which led to a rapid decline in the US dollar and US Treasury yields. The US interest rate market expects a 100BP rate cut by the end of 2024 and another 100BP cut in 2025.

"Pricing for 2024 means that the market believes that there is a possibility of a 50BP cut in one of the next three FOMC meetings. We do not think there will be a 50BP cut in September, but if the economy continues to weaken, the question of whether the Fed is lagging behind the economic situation will be raised more frequently. We believe that the Fed can send a sufficiently dovish message by cutting interest rates by 25BP and promising to accelerate the pace of easing if economic data deteriorates significantly. This approach would allow the Fed to maintain flexibility while easing policy and avoid sending the message that it has significant concerns about the outlook for the U.S. economy," Eric Roberten, global chief strategist at Standard Chartered, told reporters.

Powell did not specify the size of the rate cut, but said "the timing and pace of cuts will depend on incoming data, the evolving outlook, and the balance of risks."

Regarding inflation, Powell said that "upward risks to inflation have decreased" and he has "increased confidence that inflation is returning to a sustainable path of 2%."

"His comments differ from recent more cautious statements on inflation by some Fed officials, and we interpret them as his belief that the Fed should no longer be constrained by inflation concerns," Goldman Sachs said.

Powell also emphasized more explicitly that the Fed's tolerance for a cooling labor market has reached its limit and any further weakness is "unwelcome." He described the rise in the unemployment rate as "almost a full percentage point" rather than the smaller increase in the three-month average, noting that "downside risks to employment have increased," and twice said that "labor market conditions are weaker now than they were before the pandemic in 2019, when inflation was below 2%."

The agency believes that this means that among the two current statutory missions, maintaining price stability will give way to ensuring full employment. Earlier, the Federal Reserve believed that some weakness in the job market was the price to pay for fighting inflation, but now as the unemployment rate begins to rise, the Federal Reserve's tolerance for slowing employment has begun to decline.

The non-farm data in July showed that the unemployment rate rose unexpectedly to 4.3% (the previous value was 4.1%), the highest point in nearly three years, triggering the "Sam's Rule" for predicting recessions with 100% accuracy; the US overall CPI growth rate in July, released on August 14, fell to 2.9% year-on-year, lower than the previous value and expected 3%, falling for four consecutive months, and the first time it has fallen below 3% since March 2021.

However, Powell also pointed out that the rise in the unemployment rate was driven by a "substantial increase in the labor supply" rather than "increased layoffs," and that the pace of hiring, while no longer "frenetic," remained "solid."

“Soft landing” is good for stock and bond assets

In the absence of a recession, the Federal Reserve will formally cut interest rates, which is the most favorable scenario for risky assets. At the same time, the interest rate cut will also be beneficial to the bond market.

Shaoke Zeng, head of fund distribution for Asia (excluding Japan) at Pictet Asset Management, recently told China Business News: "Our team found that in the six periods of sharp interest rate cuts in 1989, 1995, 1998, 2001, 2007 and 2019, stocks and bonds basically benefited. Although there are years when both stocks and bonds fall, and years when bonds fall and stocks rise, overall, stocks and bonds will have a relatively good performance."

Currently, the US stock market has rebounded again and is close to a record high, sweeping away the global panic selling in early August. The S&P 500 index closed at 5634.61 points on August 24, close to the previous high of 5669.67 points.

Expectations for the U.S. stock market to hit new all-time highs in the short term remain high, and small and mid-cap stocks that are more sensitive to changes in interest rates have rebounded sharply, which means that even if the momentum of the "Big Seven" slows, the gains in U.S. stocks may be contributed by a wider range of stocks.

Goldman Sachs said that hedge funds and mutual funds continued to maintain long exposure to U.S. stocks, with mutual funds' cash balances falling to a new low of 1.4% of assets and hedge funds' net leverage at 72%, higher than the highest level in the past five years. In addition, by the beginning of the third quarter, both reduced their exposure to technology giants, and for the first time since 2022, hedge funds reduced their holdings in the "Tech Big Seven" in their long portfolios. At the same time, both increased their investments in the healthcare sector, a rotation that provides defensive and growth opportunities outside the AI ​​sector.

U.S. bond yields fell rapidly, with the two-year U.S. bond yield at 3.909% and the ten-year bond yield at 3.795%. Both exceeded 5% at their highest point last year. This also means that the bond market has fallen ahead of the policy interest rate.

Zhu Chaoping, senior global market strategist at Morgan Asset Management China, told reporters that after the interest rate cuts are launched in the future, the short-term US Treasury yields will fall faster, while the forecast range of the long-term yield (10 years) may be around 3.2%~3.5%, and may pause after falling to this range, because the long-term bond yield is an expectation of investors for the potential economic growth rate and long-term inflation in the United States, but the short-term is closely linked to the changes in the federal funds rate. Therefore, the yield curve may end the inversion of more than 40 months in the future, and a positive term spread will reappear.

Weaker dollar boosts gold, Asian currencies

The trend of the US dollar will be crucial to all major assets. As of the latest close, the US dollar index was at 100.6, down nearly 5% from its recent high.

Robertson told reporters that the decline in U.S. bond yields has exerted significant downward pressure on the dollar. However, the continued depreciation of the dollar may require the Federal Reserve to make substantial interest rate cuts while the United States avoids a recession. The U.S. stock market seems to have assumed a soft landing scenario, with major indexes approaching their highs. However, a significant weakening of economic momentum may cause stock market benchmarks to give up their recent gains, and the U.S. dollar index will also rebound.

The US dollar is expected to weaken in the short term, and future changes may have to wait until after the US election. At present, institutions are particularly optimistic about gold. After three attempts, the spot price of gold has finally broken through $2,500 per ounce recently. The interest rate cut may push the gold price to a new high again.

UBS said it will continue to be optimistic about gold, predicting that the price of gold may rise to $2,600 per ounce by the end of this year and further rise to $2,700 per ounce in June next year. The agency believes that gold can effectively hedge against risks such as geopolitics, inflation and excessive deficits.

In addition, the weakening of the US dollar is also conducive to the return of funds to the Asia-Pacific market. In the past week, the MSCI Asia ex-Japan Index (MXAPJ) rose 1%, India, the ASEAN region and Taiwan attracted a total of US$1.1 billion in foreign capital inflows, while South Korea saw a small outflow of funds.

Robertson said that with a weak dollar, Asian currencies have outperformed since July 1, especially the yen, while gains in the Malaysian ringgit, Thai baht and Indonesian rupiah have also contributed to the dollar's weakness. Low-interest Asian currencies have generally appreciated against the dollar, and the Thai baht may be one of the lowest-yielding currencies in Asia, but this has not hindered its foreign exchange performance. In the future, Asian currencies may outperform emerging markets as a whole, because as external pressures ease, Asian monetary policy may become more relaxed, which will be conducive to economic growth.

This also means that the RMB, as one of the low-interest currencies in Asia, may continue to benefit from the weakening of the US dollar, and the current depreciation expectations of the RMB have begun to reverse. As of the close, the USD/RMB was at 7.1244, and the USD/offshore RMB was at 7.116. The RMB appreciated by nearly 2,000 points from its weakest level this year.

Several traders told reporters that the liquidation of yen carry trades pushed the yen up sharply, driving up the exchange rate of the RMB, which is also a low-interest currency. Foreign exchange settlement by foreign traders may also have exacerbated the RMB's rise. Traders expect that the correlation between the offshore RMB and the US dollar index will return in the future, and the trend of the 10-year US Treasury yield is crucial.