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Author: Pei Lirui

Source: Tuchong

On August 23rd, Eastern Time, Federal Reserve Chairman Powell sent the clearest signal of interest rate cuts so far at the Jackson Hole Global Central Bank Annual Meeting, announcing that the time for policy adjustments has come. He also believes that the US economy is growing at a "steady pace" and that confidence in inflation falling to 2% has increased, easing concerns about a recession. He did not mention a "gradual" interest rate cut, leaving room for more substantial policy adjustments.

This statement triggered strong expectations in the market that the Federal Reserve is about to enter a rate cut cycle. On August 23, the U.S. stock market opened higher and ended higher. The Russell 2000 Index and the Nasdaq Index rose by 3.19% and 1.47% respectively. The U.S. dollar index weakened and approached the 100-point mark. The U.S. 10-year Treasury bond yield fell to 3.81%, and COMEX gold also re-stood above $2,550 per ounce.

Many fund companies said that judging from the performance of major asset classes during historical interest rate cut cycles, investors can focus on investment opportunities in products such as US bond funds, gold funds, and US small-cap funds. A-shares have also performed well in previous interest rate downturns. However, at the same time, short-term market optimism is high, and investors need to pay attention to possible adjustment risks.

The Fed's signal of rate cut continues to strengthen

In fact, over the past week, the Federal Reserve’s signals of a rate cut have been strengthening.

First, on August 21, the Federal Reserve released the minutes of its July meeting, which showed that some members believed that the current inflation and employment situation had reached the standard for a rate cut. On the same day, the U.S. Department of Labor significantly lowered its non-farm payroll data, showing that U.S. employment conditions began to slow earlier than expected, providing a possible scenario for a 25 basis point rate cut at the July meeting.

Then on August 23, Federal Reserve Chairman Powell spoke for the first time at the annual meeting of global central banks, saying that "the time has come for policy adjustments", boosting global market sentiment.

Guotai Fund believes that Powell's speech this time is a significant change from his previous vague attitude towards interest rate cuts. With the continued mild cooling of US inflation data and the unexpected rise in the unemployment rate in July, the certainty of starting a rate cut at the September 19 interest rate meeting is already high.

Morgan Fund also said that the downward revision of US non-farm payrolls data highlights the weakening of the US job market, which is conducive to increasing the probability of the Fed's interest rate cut and is beneficial to market sentiment. In terms of the Fed's policy, the market may be worried that the Fed's policy may be constrained in an election year, but historical data shows that the Fed maintains its independence from politics in an election year and strives to complete the dual mission of price stability and employment. Expectations for the Fed's interest rate cut in September have increased significantly.

As of August 25, data from the CME FedWatch Tool showed that the cumulative probability of the Federal Reserve cutting interest rates by 25 basis points in September was 61.5%, and the cumulative probability of cutting interest rates by 50 basis points in September was 38.5%. At the same time, the market expects the Federal Reserve to cut interest rates five times this year.

Funds hotly discuss major asset allocation plans

The US monetary policy has a profound impact on the global capital market and major asset allocation. Especially since this year, the market's expectations for the Fed's interest rate cuts have experienced many "turnarounds", and the prices of major asset classes have fluctuated greatly in the swing of "rate cut trading", "reflation trading" and "recession trading". Which assets are expected to benefit from the rate cut cycle? Many fund companies have provided major asset allocation plans.

HSBC Jinxin Fund calculated the performance of major asset classes in past interest rate cut cycles and found that in the past 5-9 interest rate cut cycles, Asian dollar bonds, gold, and equity assets achieved a relatively high positive return ratio and a relatively good average return. On the contrary, commodities and the US dollar performed relatively weakly.

For example, in the last five interest rate cut cycles, Asian dollar bonds have achieved positive returns, with an average return of 13.31%; in the last seven interest rate decline cycles, gold has achieved positive returns in six, with a positive return ratio of 85.71%, and an average return of 25.31% in the last seven interest rate decline cycles; in the last nine interest rate decline cycles, the Nasdaq Index and the S&P 500 Index have generally performed well, with a positive return ratio of 77.78% and an average yield of around 26%; in addition, A-shares have also performed well in all previous interest rate decline cycles. Even if the "surge" stage of the Shanghai Composite Index at the beginning of the market opening is excluded, there is still a positive return ratio of 57% and an average return of 10.66%.

The Wells Fargo Funds investment advisory team believes that the Fed's interest rate cuts can be divided into two categories: relief-style interest rate cuts and preventive interest rate cuts. This round of interest rate cuts is a preventive interest rate cut, which has many similarities with the interest rate cut cycles in 1995 and 2019. For example, the US economy is weakening marginally, but the consumer sector is still relatively resilient, and the inflation level has dropped to less than 3% and continues to decline moderately. Against this background, the Fed has adopted a preventive interest rate cut, and the performance of major asset classes may be similar to the interest rate cut in 1995. Before and after the interest rate cut: stocks> commodities> gold> US bonds.

If the economy rebounds significantly and PMI returns to expansion, the investment advisory team of Wells Fargo Funds believes that commodities are expected to rise, especially crude oil, which may perform well amid low inventories and supply disturbances; the pattern of strong stocks and weak bonds is expected to continue, and the downward space for US Treasury yields is limited; in terms of equities, US stocks are highly valued, and Hong Kong stocks may have greater flexibility; considering geopolitical and US presidential election uncertainties, as well as the risk of re-inflation, gold may have good support.

If there is a risk of recession, the investment advisory team of Wells Fargo Funds believes that gold and US bonds may perform better, while US stocks and commodities may face greater correction pressure.

Morgan Funds suggests that investors may wish to consider focusing on diversified asset allocation strategies, which will help diversify and enhance the ability of asset portfolios to resist risks and seize long-term opportunities. On the one hand, a soft landing of the US economy and a rate cut by the Federal Reserve remain the baseline scenario for this year, and stock assets may benefit from earnings growth and valuation recovery. On the other hand, in order to cope with risks such as the Federal Reserve's delayed rate cuts, investors also need to pay attention to the defensive side of the asset portfolio and pay attention to the allocation opportunities of US Treasury bonds and investment-grade credit bonds, which will help control the volatility of the overall portfolio.

U.S. bonds, gold and small-cap funds are expected to benefit

Based on the performance of the above-mentioned major asset classes, many fund companies suggest that during the Federal Reserve's interest rate cut cycle, investors can focus on investment opportunities in fund products such as U.S. bond funds, gold-themed funds, and U.S. small-cap funds.

Among them, the main investment targets of U.S. bond funds are Chinese dollar bonds and U.S. Treasury bonds. There are currently about 15 U.S. bond funds on the market, of which 9 products have achieved returns of more than 3% in the past three months. The yields of ICBC Global Dollar Bond A RMB, Changxin Global Bond RMB, and Dacheng Global Dollar Bond A RMB in the past three months have reached 6.17%, 4.44%, and 4.37%, respectively.

Haoma Fund analysis believes that whether the Fed is reducing interest rates for prevention or relief, it will usually drive down long-term interest rates of US bonds. Data shows that within six months after the Fed's first four rounds of interest rate cuts in September 1984 (soft landing), July 1995 (soft landing), January 2001 (hard landing) and September 2007 (hard landing), long-term interest rates of US bonds all fell to varying degrees, which is beneficial to the performance of US bond funds. Among them, short-term US bonds have a higher degree of certainty, and long-term products can be paid attention to after the interest rate cut is implemented.

Regarding gold, Guotai Fund stated that under the background of excessive money supply and monetization of fiscal deficits, the US dollar credit system has been challenged; coupled with the frequent global geopolitical turmoil that has promoted the diversification of asset reserves, the demand for gold as a safe asset has continued to increase. The global trend of "de-dollarization" makes it possible for gold to become a new round of pricing anchor, making it possible for precious metals to have upward momentum.

There are currently 17 gold ETFs in the market, including 13 gold commodity ETFs and 4 gold stock ETFs. It is worth noting that recently, there has been a clear divergence in the trend of gold commodity ETFs and gold stock ETFs. Among them, 13 gold commodity ETFs have risen by more than 3% in the past three months, while the 4 gold stock ETFs have fallen by more than 8% in the same period.

At the same time, the Fed's interest rate cuts may also attract funds to flow into risky assets represented by US stocks, especially small and medium-sized technology companies that are sensitive to interest rates. For example, after Powell's speech on August 23, the Russell 2000 small-cap index, which represents small-cap stocks in the United States, rose 3.19% in a single day, outperforming the Nasdaq 100 index, which rose 1.18%.

Yu Jin, deputy director of the international business department of PuRong Ansheng, said that when interest rates are lowered and financing costs are reduced, it is expected that companies' capital expenditures will increase and the market's expectations for the profitability of related stocks will be improved. This is especially important for small and medium-sized companies with limited cash flow.

In the previous environment of excessively high interest rates in the United States, small and medium-sized software technology companies continued to be under pressure in terms of capital expenditures, which inhibited the research and development of technologies other than AI. With the possibility of a US interest rate cut approaching, technology companies are expected to speed up their research and development, accelerate long-term development, and strengthen the market's expectations for their profit prospects.

However, some companies have pointed out that short-term market optimism is high and investors need to pay attention to possible adjustment risks. Guotai Fund said that Powell's speech at the Jackson Hole conference was dovish, which also boosted the market's confidence in a soft landing of the US economy, which is conducive to the rebound of gold, US bonds and global equity markets. However, in the future, under the mixture of interest rate cuts, US election disturbances and global geopolitical conflicts, the volatility of the global capital market is expected to continue to recur.