On September 19, the Federal Reserve began to cut interest rates as scheduled, ending the tightening cycle that had been in place since March 2022. However, the market performance that day was quite mixed, with various assets experiencing significant volatility.

Although the Federal Reserve had been hinting at a rate cut before this interest rate meeting, the direct 50 basis point cut exceeded the market's expectations by far. Since the 1990s, a similar 50 bps cut has only happened 3 times, each occurring during critical moments - the bursting of the internet bubble in 2001, the subprime crisis in 2007, and the COVID-19 pandemic in 2020.

Therefore, the unexpectedly large rate cut raised concerns in the market about whether the Federal Reserve had seen an unusual 'alarm.'

At the press conference, Chairman Powell took a relatively hawkish stance, making every effort to dispel the link between rate cuts and recession, warning the market not to extrapolate current rate cuts in a linear fashion, emphasizing a 'I am not, I do not, stop making blind assumptions' Triple Crescendo. The core idea can be summarized as - rate cuts are more for stabilizing the job market, and the Federal Reserve will take action based on data at the time, whether quickly or slowly.

Prior to this, influenced by fluctuating economic data, the Federal Reserve had repeatedly postponed rate cuts. After finally coming out, the Fed's performance was contradictory, not only causing market divergence but also turning its view on economic fundamentals into a 'Schrodinger's cat.'

It can be foreseen that for a long time in the future, the U.S. economy will be in a state of combination of a 'soft landing' and a recession, and each economic data point, whether exceeding or falling below expectations, could prompt the Federal Reserve to change the rate cut pace, thereby causing market views to swing between two paths.

Before drawing conclusions, global assets priced with U.S. Treasury rates as an anchor are inevitably amplified many times by the market sentiment of rising and falling at times. Perhaps looking back, everything may seem logical, but in every present moment of history, insiders truly understand the full picture of the era. Besides going with the flow, ordinary investors should also seek proactive strategies.

But before that, the first thing to understand is how various assets will fluctuate under different scenarios.

Volatility is the main theme.

Undoubtedly, the pace of rate cuts by the Federal Reserve directly affects the U.S. market represented by U.S. stocks and U.S. bonds.

If the deduction is made according to the path of a "soft landing," the limited downward space for interest rates during the entire rate cut cycle means that a faster initial rate cut speed is actually an overdraft and will lead to a slowdown in the subsequent pace of rate cuts.

Historically, U.S. bonds are more sensitive to rate cuts and will react in advance under market expectations, outperforming U.S. stocks in the early stages of the cycle. As the effects of easing become apparent and the economy recovers, rate cut expectations will be compressed, and U.S. stocks will gradually outperform U.S. bonds with strong fundamental support.

Conversely, if the U.S. economy collapses into another state known as a "recession," then under the drag of deteriorating economic data, the Federal Reserve will have to open up space for rate cuts. Correspondingly, U.S. bonds can naturally continue their earlier strength, while U.S. stocks may experience a significant decline.

Which of these scenarios will unfold remains to be continuously verified, with two important observation windows being inflation and employment. Although the inflation rate has not yet reached the ideal 2% target set by the Federal Reserve, it is temporarily under control and moving towards the target convergence. The real challenge lies in employment.

Previously, economists had warned that the Federal Reserve was "playing with fire." The relevant unemployment rate data indicate that if the Federal Reserve does not adopt a gradual rate cut approach soon, it may meet Sam's Law and be forced to take more aggressive economic measures. Sam's Law refers to when the U.S. 3-month unemployment rate moving average minus the previous year's low unemployment rate exceeds 0.5%, it signifies an economic slump phase. Every economic slump phase in the past has followed this law.

This unexpected rate cut action by the Federal Reserve seems to have stemmed from this warning.

However, at the same time, Claudia Sahm, the proposer of the "Sahm Rule," stated in an interview in August that the current rise in the unemployment rate is mainly due to a surge in immigration, which has facilitated the recovery of the job market, rather than a weakening demand for workers. Therefore, the "Sahm Indicator" can no longer be used as a recession indicator to refer to.

Taking this as a starting point, there are also Powell's "hawkish comments" and many analysts who believe that the US economy will experience a "soft landing." As for who is right and who is wrong, subsequent economic data will prove, for ordinary investors, it is important not to predict, but how to respond.

Regardless of which path is taken, a rate cut is not a bad thing for the domestic market. After all, under the constraints of the US-China interest rate differential and exchange rates, the Federal Reserve's shift to a rate-cut cycle has indeed opened up space for domestic policies. In addition, there are also some assets closely linked to US dollar liquidity that can directly benefit, such as Hong Kong stocks, which have shown greater resilience in the past few trading days.

However, amidst the clamor, the market still faces another layer of uncertainty, which is the upcoming US presidential election. Although Harris slightly outperformed in the latest presidential debate, the outcome of the election remains uncertain. If Trump is re-elected, it may lead to a series of policy shifts.

Therefore, as various assets have already priced in a partial rate cut and the domestic market has experienced a violent rebound, how long institutional investors' "tactical increase in positions" will last remains to be seen.

Until all the dust settles, volatility is destined to remain the main theme of the future.

In the perplexing environment, the best choice for ordinary investors is not to bet on a particular possibility or type of asset, but to diversify their asset allocation, introducing different assets with weak correlations into their portfolio to effectively resist volatility and control drawdowns.

Beyond the loose monetary policy pace and geopolitical uncertainties, gold is a type of asset that cannot be ignored.

The uniqueness of gold.

Although from a medium to short-term perspective, the attributes of gold and US bonds are similar, both are considered safe-haven assets.

The Fed's interest rate cuts will reduce the holding cost of gold, so the price trends of the two will also converge. If the first scenario occurs, with the gradual recovery of the US economy and the 'recession warning' lifted, then gold, like US bonds, may face certain selling pressure.

However, in the long term, gold has another unique logic that cannot be compared to US bonds, that is, the repricing of the gold's currency attribute after the foundation of the US dollar shakes.

J.P. Morgan has a famous saying, 'Gold is money, everything else is credit.' With the weaponization of the US dollar settlement system – sanctioning countries like Iran, Russia, etc., relying excessively on this fiat currency is no longer the best choice. Since 2018, the proportion of the US dollar in global forex reserves has been decreasing year by year.

Correspondingly, including China, central banks of various countries have shown significantly increased enthusiasm for gold, with a sharp increase in net purchases over the past two years. According to a survey by the World Gold Council in 2023, 62% of the surveyed central banks stated they would increase the proportion of gold in total reserves over the next 5 years, whereas in 2022 this number was only 42%.

Therefore, apart from the Fed's pace of interest rate cuts, gold's returns have another layer of protection.

From the perspective of portfolio allocation value, gold is uncorrelated with traditional stock and bond assets, effectively avoiding the risk of stock market beta decline and a dual decline in stocks and bonds. According to the product backtest done by Guotai Junan Securities, an investment portfolio constructed with weights of gold ETFs, SSE dividend index funds, bond funds, and money market funds, although in some years the performance is weaker than a single product, the net asset value performance is stable in the long term, providing a better holding experience.

In fact, as early as the beginning of this round of bull market in gold, the purchase of gold jewelry has already sparked a craze among young people. While consumer fund managers are still facing the age-old question of whether young people drink baijiu, jewelry stores have already attracted a group of post-00 customers obsessed with "saving gold beans".

However, although physical gold has authenticity and touch, it requires additional craftsmanship fees, and storage and custody present certain difficulties and risks, and the way to cash out is quite cumbersome.

From an investment perspective, obviously the cost-effectiveness of gold ETFs is higher. Compared to physical gold, the investment threshold for gold ETFs is lower, and they have higher liquidity.

Epilogue

On the afternoon of September 24, 2008, at the Waldorf Astoria Hotel in New York, Chinese Premier ****, facing well-known figures in the American economic and financial circles, said in a decisive tone: "In the face of economic difficulties, confidence is more important than gold and currency."

The background of this statement is that the subprime mortgage crisis originated in the United States eventually evolved into a global financial crisis, which had a huge impact on the world economy. The Federal Reserve cut interest rates by 500 basis points in less than a year and a half, hitting the floor rate, and started quantitative easing. The dollar depreciated, gold was sought after by the market, continuing the bull market since 2002.

After this speech, domestic policies quickly shifted, launching the far-reaching four trillion yuan plan, successfully recovering from the crisis, and becoming a cornerstone of the global economy. It wasn't until 2011 when the U.S. economy recovered, the Fed gradually withdrew from quantitative easing, the dollar officially strengthened, that the gold bull market finally came to an end.

Currently, the situation facing the United States economy in this round may not be as grave as in 2008, but the weaponization of the dollar settlement system has made people's distrust of the dollar even stronger than before.

Perhaps not only do we need to wait for the confirmation of a soft landing signal in the US economy, but also for the proportion of the US dollar in global foreign exchange reserves to reach a new balance with people's confidence in the US dollar before the importance of gold can once again take a back seat.

Editor/Rocky