When Will the Turning Point Come After Interest Rate Cut?
Why did the Federal Reserve cut interest rates by 50bp significantly?
The September FOMC meeting cut interest rates by 50bp, and the new dot plot indicates that there will be a total of 100bp of rate cuts this year, 100bp next year, and 50bp the year after, making the total for this easing cycle 250bp. This aligns with our consistent prediction that the Federal Reserve is not engaging in shallow and delayed rate cuts, but rather deep and rapid ones, with a range of 200-300bp.
Despite the Federal Reserve's denial of being behind the curve, the initial 50bp rate cut effectively acknowledges that the easing cycle has started too late. We have repeatedly warned since the beginning of the year that U.S. growth and inflation would move downward in tandem, and the Federal Reserve should have begun cutting rates in Q1. However, systematic deviations in U.S. Q1 growth and inflation data may have misled the Federal Reserve's judgment, causing the start of rate cuts to be delayed until September. To avoid further expansion of recession risks, the Federal Reserve chose to cut rates by 50bp for the first time, catching up on the easing progress.
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After the 50bp rate cut, major asset classes such as stocks, bonds, commodities, and gold initially rose and then fell, possibly suppressed by the hawkish signals released by Powell at the press conference: Powell stated that the 50bp cut should not be considered a fixed pace for future rate cuts[1], and the Federal Reserve could slow down or even pause rate cuts based on economic conditions; the neutral rate could rise significantly and would not return to the era of low or negative interest rates. Correspondingly, we have noticed that the dot plot has revised the long-term neutral rate upwards to 2.9%.
The September employment and inflation data were not very bad, but the Federal Reserve still chose to cut rates by 50bp, indicating that the threshold for rate cuts is very low. If necessary, the Federal Reserve can also further accelerate rate cuts on the current path, so rate cuts remain a highly certain investment direction at present. In our report published in 2023, we calculated the medium-term center of the 10-year U.S. Treasury rate to be 3.5%, and the current rate is close to 3.8%. During cyclical downturns, asset prices can also operate below the center, so there is still ample room for interest rates to move lower. Our panoramic economic model shows that the U.S. is experiencing a cyclical downturn and sectoral divergence, with an uncertain economic outlook, so we temporarily maintain a standard allocation to global equities and a low allocation to commodities such as copper and oil.
When can we expect an economic inflection point after the rate cut?
It takes time for interest rate changes to be transmitted to the economy. The Federal Reserve began raising rates in 2022, and the U.S. economy only gradually showed downward pressure in 2024. Similarly, the economic inflection point may not appear immediately after the rate cut. We have reviewed the 13 Federal Reserve rate-cutting cycles since 1950 to provide a reference for predicting the current economic inflection point. In the past 13 rate-cutting cycles, the U.S. economy fell into recession 10 times, and only avoided recession in the 1995, 1984, and 1966 cycles, so the historical success rate for soft landings is not high.
Since in some rate-cutting cycles, there is a long interval between the timing of the Federal Reserve's rate cuts and the timing of the recession, the economic and market environment in the early stages of these rate-cutting cycles is actually similar to a soft landing scenario. This period corresponds exactly to the economic and asset trends in the next 1-2 quarters that we are most concerned about at present. Therefore, in the analysis below, we also consider "no recession within one year after the Federal Reserve's rate cut" as a soft landing scenario, which includes the 1989 and 2019 rate-cutting cycles. Thus, under the new definition, we have 8 hard landings and 5 soft landings.
In hard landing periods, the medians of PMI, GDP growth, and unemployment rate show that the economy usually takes about 9 months to gradually stabilize, while the unemployment rate continues to rise. In soft landing periods, PMI and GDP growth also continue to decline for about 6 months before bottoming out and rising, while the unemployment rate remains stable.
The above review confirms our judgment that regardless of whether a recession eventually occurs, the downward economic trend may continue for 2-3 quarters after the rate cut. Even for rate-sensitive sectors, historical reviews show that the upward inflection point will not appear quickly: in hard landing periods, U.S. credit and housing price growth can only bottom out and rise about 1 year after the Federal Reserve begins to cut rates. In soft landing periods, U.S. credit growth also faces about 10 months of downward pressure, and housing price growth only remains stable, without rising quickly after the rate cut.When will the market inflection point be seen after interest rate cuts?
We have consistently advised overweighting US Treasuries and gold, underweighting commodities such as copper and oil, and have warned of global stock market volatility (as seen in "Asset Implications of the Fed's Halt in Interest Rate Hikes" and "2024 H2 Outlook for Major Asset Classes"). This year, gold has surpassed $2,600, setting a new historical high; the yield on the 10-year US Treasury note has fallen nearly 100 basis points to 3.6%, with copper and oil experiencing the deepest drops of 12% and 19% respectively from their highs, and global stock markets have seen intense volatility in August and September, validating our predictions.
Looking ahead, investors are now focusing on when US Treasuries and gold will confirm a downward inflection point, when commodities will confirm an upward inflection point, and when stocks will end their volatility. From historical patterns, we have found that regardless of a recession, the 10-year US Treasury rate still has an average of about 70 basis points of downward space on a two-quarter scale after interest rate cuts.
Under a soft landing scenario, the risk of gold falling is limited, and it rises more in the case of a hard landing, but regardless of a recession, the median high point in the 2-3 quarters after rate cuts is in the 5%-10% range. Therefore, we believe that the downward inflection point for US Treasuries and gold will not appear quickly after rate cuts and can still be maintained as an overweight position.
At the same time, due to the significant gains in these two types of assets, future volatility may increase, which is also in line with historical patterns. We suggest taking advantage of market fluctuations to add positions when prices are low.
The trend of US stocks is highly dependent on whether there is an economic recession or not. In the case of a hard landing, stocks average a 10% decline in the first six months before rebounding, while in a soft landing scenario, they continue to rise.
Structurally, the S&P 500 and Russell 2000 perform better during economic recessions, while the Nasdaq faces greater downward pressure. In a soft landing, the Nasdaq tends to perform better. Since we are uncertain about the economic outlook, we maintain a neutral stance on the prospects for overseas stocks.
The US dollar faces some downward pressure in the case of a hard landing, gradually bottoming out over a seven-month period with the deepest decline around 5%, before rebounding in the second half of the year. In a soft landing scenario, the dollar is usually stronger and more volatile in the first three quarters but weakens in the fourth quarter.
Regarding commodities, after the Fed raises interest rates, the overall economic demand is constrained, and regardless of a recession, copper, as an important industrial metal, maintains a downward trend in the first eight months after the Fed cuts rates. Oil prices maintain an upward momentum in a hard landing scenario but fall in a soft landing scenario, possibly reflecting the economic recessions caused by supply shocks (oil crises) in history, which may offer limited guidance for the current market outlook. Although domestic and foreign policies have recently shifted, and optimistic expectations for economic growth have driven a phased rebound in commodity prices, considering the aforementioned historical patterns and the time it takes for interest rate declines to be transmitted to the real economy, and the ongoing risks of economic cycle downturns, we believe that more signals are needed to confirm an upward inflection point for commodities.