In the early morning today, the Federal Reserve announced its first interest rate cut since 2020, lowering the benchmark interest rate by 0.5 percentage points to prevent the labor market from slowing down. This morning, the Hong Kong Monetary Authority lowered the benchmark interest rate by 50 basis points to 5.25%. It seems that a global upheaval has begun.

So, how much impact does the strong interest rate cut by the Federal Reserve have on the market?

The stock markets in Japan and South Korea opened higher.$Nikkei 225 (.N225.JP)$The index opened with a 1.7% increase.$SoftBank Group (9984.JP)$up more than 2%,$Mitsubishi (8058.JP)$Up more than 1%; the Japanese stock market rose rapidly in the early trading session, and the Nikkei 225 index's gain expanded to 2.3%.$Hitachi (6501.JP)$rose by more than 3%,$Keyence (6861.JP)$and$Fast Retailing (9983.JP)$ Up more than 2%. $Korea Composite Index (.KOSPI.KR)$ The market opens up 0.7%.

Looking at the market, the US stocks dipped slightly last night, but what's more worth paying attention to is the Japanese yen. As expected, the 50 basis point rate cut by the US dollar is a major bullish factor for the yen, but the yen's performance this morning is relatively weak. The US dollar is also not as weak as expected, and the carry trade reversal has not materialized. Instead, gold and oil are experiencing selling pressure. So what is the logic behind this?

Also worth noting is the political impact. This is the closest the Federal Reserve has come to starting an easing cycle in the United States just before a presidential election in nearly half a century. Although interest rate policy rarely remains unchanged during election years, there have only been two instances where a completely new rate cut phase was initiated less than 10 weeks before election day—namely in 1976 and 1984. Republican presidential candidate Donald Trump earlier this year expressed his view that the Federal Reserve might lower rates to help the Democratic Party win on November 5th. Trump stated last month that the president should have a say in the Federal Reserve's decisions.

Market fluctuations

Investors were initially pleased with the rate cut on the US dollar. $S&P 500 Index (.SPX.US)$N/A.$Dow Jones Industrial Average (.DJI.US)$Both gold and silver reached historic highs, $Russell 2000 Index (.RUT.US)$ rising nearly 2%, while the US dollar fell across the board.

However, the stock market and the rise in gold prices gradually faded, and the US dollar rebounded from a 14-month low, closing higher during the US trading session. The bond market, on the other hand, showed foresight. US Treasury yields rose across the board, with long-term bond yields rising even more. This may be due to potential concerns about inflation and a more accommodative financial environment, or it may be because the Federal Reserve slightly raised its long-term forecast for the federal funds rate.

However, analysts believe that the Fed's rate cut this time marks the sixth time in the past 30 years that the central bank has shifted from raising interest rates to cutting them. Typically, when the Fed starts cutting rates, it doesn't know whether it will take small steps like it did in 1995 and 1998 to avoid a recession, or if it will start a longer series of rate cuts like it did in 2001 and 2007. The Federal Open Market Committee indicated through its dot plot that it will cut rates by another 50 basis points by the end of this year, in line with market pricing. The individual officials' dot plot shows expectations for another 100 basis points of rate cuts by the end of 2025 and another 0.5 percentage point cut by 2026. Overall, the dot plot indicates a decline of about 2 percentage points in the benchmark rate from Wednesday's level.

The Federal Reserve stated that it lowered rates by half a percentage point due to being "more confident" that inflation is moving towards the central bank's 2% target, and that it is currently focused on maintaining a healthy labor market.

Brian Jacobsen, Chief Economist at Annex Wealth Management in Menomonee Falls, Wisconsin, said, "The Federal Reserve ended the pause with a bang. This is a strong signal that they cut rates by 50 basis points and expect to cut another 50 basis points later this year."

After the US stock market closed today, the reaction gradually turned positive, and the three major US stock index futures all rose.

Changes in interest rates in various regions

With the US rate cut, expectations of interest rate changes in various regions are also evolving. The Hong Kong Monetary Authority lowered its benchmark interest rate by 50 basis points to 5.25%. The Indonesian central bank lowered its rate by a quarter of a percentage point on Wednesday. More attention is also focused on China, with the growing expectation of a decrease in existing home loan rates, and the approaching September 20th adjustment of the LPR. Many analysts believe that the US dollar rate cut is also a time window for changes in China's money supply and prices.

From a market perspective, on Thursday, Asian investors will also focus on New Zealand's GDP, unemployment data from Australia and Hong Kong, and trade data from Malaysia. Traders may also adjust their positions before the release of Japan's inflation data, and the interest rate decisions by the Bank of Japan and the People's Bank of China on Friday.

Chief Economist Hong Hao of Founder Securities Group stated that under the Fed's rate cut, the renminbi exchange rate will see an opportunity for appreciation, and at the same time, the depreciation expectations will slow down, with funds expected to flow back to China. Whether it's because US stocks are overvalued, or because the rapid decline in returns from funds left in the US, it will lead to a decrease in yield expectations between China and the US, increasing the momentum of funds flowing back to China.

China International Capital Corporation believes that a 50 basis point rate cut is an unconventional start, in line with CME expectations, but exceeds Wall Street forecasts. Another two 25 basis point rate cuts within the year, lower than the pre-meeting CME futures path, explain the rise in interest rates. Powell emphasized that the 50 basis point rate cut should not be extrapolated as a new benchmark, considering the neutral interest rate significantly higher than before the pandemic. Emphasizing the lack of any signs of a recession, and no victory achieved on inflation issues. The Fed sees weakness in the job market, otherwise it would not have taken the "unconventional" operation of starting with a 50 basis point rate cut, but also strives to create an image of being "ahead of the market but not in a hurry". From the market response perspective,Its price has soared to a historic high, closely related to market expectations of interest rate cuts by the Federal Reserve.Huang Haolong, the chief economist of SII Group, believes that with the rate cut by the Federal Reserve, the renminbi exchange rate sees an opportunity for appreciation, while the slowdown in depreciation expectations may see the capital inflow to our country slowing down. Whether it's due to the high valuation of US stocks or the rapid drop in returns on funds left in the US, it will lead to a decrease in the expected yield difference between China and the US. This will increase the momentum of capital inflow into our country. An interesting paradox is that a steeper initial slope slows down the subsequent rate cut path, as easing will have a quicker effect in rate-sensitive sectors such as real estate.

Of course, this means that the data in the following months will be crucial. If it can hold up, risky assets will perform better and safe-haven assets will be close to an end. Monetary policy will return to neutral, with the high and low points of the 10-year US Treasury yield at 3.8% and 3.5% respectively. Under the current environment, US Treasury bonds and gold have yet to be disproven and still present some holding opportunities, but the short-term space is limited. If subsequent data confirms that the economic pressure is not significant, then it should "fight and retreat". In comparison, it is more certain that US short-term bonds, real estate chains (even driving China's related export chains), and copper are receiving gradual attention, but they are still slightly biased to the left and need verification.

For the Chinese market, the main impact comes from how the effects of external easing are transmitted, that is, the response of domestic policies. Hong Kong stocks are sensitive to external liquidity and will follow a decline in the linked exchange rate with greater elasticity than A-shares. Similarly, at the industry level, growth stocks sensitive to interest rates (biotechnology, technology hardware, etc.), sectors with higher proportions of overseas US dollar financing, Hong Kong stocks with local dividends or even real estate, as well as export chains, may also benefit marginally.

Editor/Emily