Source: Securities Times
Authors: Chen Xiachang, Roman
On December 13, local time, the last interest rate meeting of the Federal Reserve this year came to an end. The Federal Open Market Committee (FOMC) announced that it will keep the federal funds rate target range between 5.25% and 5.5% unchanged. This is the third time since the interest rate meeting in September this year that the Federal Reserve has suspended interest rate hikes. Since the Federal Reserve began this round of interest rate hikes in March 2022, as of July this year, interest rates have been raised 11 times, with a cumulative interest rate increase of 525 basis points.
The market generally expects the Fed to end the current cycle of interest rate hikes and switch to cutting interest rates next year.
The Fed's new economic forecast shows that the median expectations of Fed officials for 2024 interest rate cuts are 75 basis points, higher than the 50 basis points expected before the meeting. Federal Reserve Chairman Jerome Powell (Jerome Powell) expressed the view that the interest rate hike cycle is “at or near its peak” because it is “unlikely” that the Commission will raise interest rates again.
Although Powell did not clearly state the end of the interest rate hike cycle, there are growing signs that the Fed will no longer use interest rate hikes to curb inflation, and that in order to boost the economy, it is very likely to start cutting interest rates next year.
A number of analysts interviewed by reporters said that the Fed's policy shift may have a major impact on global capital markets.
The Federal Reserve stated that interest rate hikes are close to completion
Ellen Zentner, chief economist at Morgan Stanley, said in an interview with the Securities Times, “Judging from the content of the statement, it is basically in line with our expectations. Against the backdrop of the economic slowdown but still being resilient, this 'opens the door' for next year's interest rate cut. We expect to see our first interest rate cut in June next year, then cut interest rates by 25 basis points at every meeting in September and after the fourth quarter. By the end of 2025, the policy interest rate will fall to 2.375%, so it is recommended to hold a long position on the US dollar. The market has already fully priced the Fed's drastic easing policy in the next few quarters, yet interest rate differences still support the US dollar.”
Yan Zhaojun, a strategic analyst at Sino-Thai International, told reporters that the Federal Reserve achieved positive results in fighting inflation in 2023, the labor market is slowing moderately, and the impact of policy tightening and financial conditions on households and businesses will gradually surface. It is expected that the interest rate hike cycle has come to an end, that the growth rate of the US economy will gradually slow in the fourth quarter and 2024, and that inflation has declined somewhat year-on-year. The decline in the inflation rate may be slower than market expectations, thereby limiting the shift in monetary policy. It is expected that interest rate cuts will begin at the end of the second quarter of next year and enter a cycle of interest rate cuts. Interest rates will be cut by 50-75 basis points throughout the year. It is expected that 10-year US Treasury yields and the US dollar index will continue to decline slightly.
Although analysts generally expect the Fed to enter a cycle of interest rate cuts, the UBS Wealth Management and Investment Director's Office believes that the market's expectations for interest rate cuts are still more aggressive than the Fed's predictions. The market expects interest rates to be cut too fast, and the experience of the current interest rate cycle is that we need to listen more to the guidance of the Federal Reserve in cutting interest rates. Therefore, the UBS Wealth Management Investment Director's Office believes that the Fed will not raise interest rates further, and will begin cutting interest rates before mid-2024, and cut interest rates by 75 basis points by the end of 2024.
Liu Gang, an analyst at CICC, also believes that the softening of the Fed's attitude may mean that interest rate cuts will come earlier than the agency originally anticipated in the second half of 2024, but fundamentals do not support starting interest rate cuts in the short term. Comparing with the experience of 2019, the arrival of interest rate cuts may require some iconic fundamental changes. At that time, interest spreads on long-term and short-term treasury bonds were inverted for the first time, and this time it may be that the unemployment rate or inflation have broken through the threshold.
When the interest rate hike cycle is over, how are assets allocated?
How will the end of the Fed's interest rate hike cycle and the upcoming rate cuts affect the world's major assets?
Li Zhao, an analyst at CICC, reviewed the asset performance after 14 rounds of the Fed's interest rate hikes over the past 50 years and before interest rate cuts began. From the perspective of median return on assets and win rate, the performance of various assets is ranked by US debt, US dollars, commodities, US stocks, and gold.
However, the time series of asset prices in China is relatively short. Most assets have only experienced the last 2-4 rounds of the Fed's policy platform period, so the effects of the historical recovery have been relatively limited. Li Zhao discovered that after the Fed's interest rate hike ended and before interest rate cuts began, Chinese stocks, commodities, and exchange rates all performed well, but this is probably more related to China's own macro-environment. For example, in 2000, the domestic economy bottomed out, and brokerage firms were allowed to increase capital; in 2006, the economy grew rapidly, and stocks were reformed; the timing coincided with the Fed's policy platform period.
During this round of interest rate hikes, the US stock market as a whole fell and then rebounded. Among them, the S&P 500 index continued to fall from around 4,600 points in March 2022 to around 3,500 points in October of that year, then stopped falling and rebounded. Recently, it has returned to 4,700 points, one step away from the record high of 4818.62 points set in December 2021. Meanwhile, the Dow Jones Industrial Index, which focuses on large-scale industries and businesses, recently reached a record high of 37305.16 points.
Will the Fed's policy shift stimulate US stocks again?
Li Zhao believes that expectations of recent interest rate cuts are heating up, boosting risk sentiment. US stocks have clearly rebounded, but risks may also be accumulating. If the US economy clearly declines during the Fed's interest rate cut, and a smooth “soft landing” is not possible, US stocks may still be under pressure in the future.
However, the UBS Wealth Management and Investment Director's Office believes that for the US stock market, favorable factors have already been taken into account in stock prices, so the threshold for a further sharp rise in the index level is relatively high. Since the Federal Reserve actually admits that the economy is “in the back of the cycle,” the agency continues to focus on high-quality companies that are most likely to achieve profitable growth in times of economic slowdown.
Wei Wei, a strategy analyst at Ping An Securities, believes that US stocks are still likely to continue to be strong under the leadership of technology stocks. Wei Wei believes that AIGC's breakthrough in artificial intelligence has triggered global innovation and take-off, and that the AI-centered industry segment will benefit in the future. This round of bull market in the US stock technology sector may continue. At the same time, the pharmaceutical innovation cycle plus the Fed's interest rate cut begins, the pharmaceutical industry may be expected to gradually break out of the bottom and focus on the direction of innovative drugs.
Emerging markets are becoming more attractive
The Fed's policy shift will also have a major impact on emerging market stocks, including China.
Lin Wenjia, an analyst at SPDB International, and others believe that rising expectations of the Fed's interest rate cut will help to repair the market. Before interest rate cuts began after the end of the previous interest rate hikes, interest rates on US bonds peaked and fell, and the decline in risk-free interest rates helped ease valuation pressure. During this period, the world's major stock indexes all recorded increases. Overseas Chinese stocks were more flexible, the health care, technology and other sectors had clearly recovered their valuations, and growth stocks performed better.
Furthermore, after interest rates were cut, the depreciation of the US dollar increased the attractiveness of emerging markets, and companies holding foreign exchange assets and liabilities may directly benefit. If the interest rate cut cycle begins, it indicates that the economic growth rate may slow down, and the performance of global stock indexes will weaken, but the performance of emerging markets is relatively good. Currently, the position of foreign investors in the Chinese stock market is still low. If the economic cycle between China and the US is reversed and the RMB enters an appreciation channel, it is expected to attract foreign capital back to the Chinese stock market, which may directly support the liquidity of overseas Chinese stocks.
Meanwhile, the Hong Kong stock market will also benefit from the Fed's policy shift.
Yan Zhaojun told reporters that as the growth rate of US inflation declines, it is expected that in the middle of next year or “insurance” interest rates will be cut by 50-75 basis points, the US dollar index will also weaken slightly. The passive appreciation of the RMB will ease the squeeze on the valuation and liquidity of Hong Kong stocks. The release of liquidity pressure on Hong Kong stocks will show a “slow, then fast” trend.
Historically, the Hong Kong stock Hang Seng Index has a strong negative correlation with the US dollar index. “If the Fed does not raise interest rates, Hong Kong's local capital flow is expected to solidify and pick up. The year-on-year growth rate of Hong Kong's M2 money supply bottomed out in February 2023 and gradually rebounded. The year-on-year growth rate of Hong Kong's foreign exchange positions and US dollar spot liabilities also bottomed out in May 2023, indicating that the pressure on capital outflow from Hong Kong is easing. If risk-free interest rates on overseas US dollars stop rising, interest spreads between Hong Kong and the US narrow, compounded by a recovery in China's nominal GDP growth, capital is expected to flow back to Hong Kong in part.” Yan Zhaojun said.
Commodities: Gold is expected to continue to rise
Guolian Securities analysts Ding Shitao and Liu still believe that the historical review shows that in the six complete monetary policy cycles since 1980: during the interest rate platform period, the price of gold showed a volatile rise, with an average increase of 5.4%; after entering a cycle of interest rate cuts, the price of gold rose 5 times, with an average increase of 25%. Under major changes that have not occurred in the world in 100 years, global geopolitical risks are rising, and central banks around the world continue to increase their gold reserves in the context of de-dollarization... Gold is still in an upward cycle.
As far as copper is concerned, copper has both financial and commodity attributes. As the Fed's monetary policy gradually transitions from a cycle of interest rate hikes to a cycle of interest rate cuts, copper prices are expected to recover. Looking at supply, the global supply of copper concentrate is gradually shifting from loose to insufficient. According to SMM forecasts, the global copper concentrate oversupply will drop from 120,000 tons in 2023 to 70,000 tons in 2024, and will shift to a shortage of 300,000 tons in 2025. In terms of demand, China accounts for more than 50% of global consumption of refined copper. Under the global energy structure transformation trend, copper consumption in the new energy sector, including photovoltaics, wind power, and new energy vehicles, will gradually rise. According to SMM forecasts, by 2026, the share of copper consumption in the new energy sector is expected to rise to about 20% from 9% in 2022. Resonance of supply and demand factors is expected to drive the center of gravity of copper prices upward.
Editor/Somer