Looking ahead to the Fed’s rate cut: When it will be cut is a foregone conclusion

"The time has come to lower the target interest rate, and now is the time to adjust the policy."

On August 23rd local time, Federal Reserve Chairman Powell attended the Jackson Hole conference and released a clear signal of interest rate cuts in his speech. After the 2008 financial crisis, the Jackson Hole conference often became a forward-looking guide for various monetary policies. This speech is seen as a signal that the interest rate cut cycle is about to begin, adding fuel to the already highly expected September interest rate meeting.

At the end of August, how will the Fed's interest rate cut be implemented? This article will briefly analyze the issue of the Fed's interest rate cut.

01 Why are the expectations of interest rate cuts strengthened?

In order to affirm the correctness of past decisions, Powell focused on the reasons for changes in US inflation in this speech. According to Powell's conclusion, the Fed's continued suppression of aggregate demand and the resilience of the US economy after the United States emerged from the epidemic have jointly contributed to the conclusion that inflation has fallen. Overall, Powell believes that his anti-inflation policy since 2020 has achieved relatively satisfactory results.

From Powell's speech on August 23, the priority of US employment data is the main reason for the start of the interest rate cut process. Powell made it clear at the meeting that he "does not seek or welcome a further cooling of the labor market," which seems to be intended to put the employment target before the inflation target. In the past two years of interest rate stagnation, the market generally believed that the decline in inflation targets was tied to the rise in unemployment. Now Powell's statement has changed from the past "inflation-only theory." The reason for this may be the employment and wage census data (QCEW) for the first quarter of 2024 released by the U.S. Bureau of Labor Statistics. According to the data from the Department of Labor, the total number of non-farm employment in the United States in the first quarter of 2024 was 157.21 million jobs, which was 818,000 jobs short of the total number of non-farm employment announced in March 2024. Based on this, the non-farm data also significantly revised down the employment data of the past labor market.

It is reported that the data of the U.S. Department of Labor is based on the employment positions with unemployment insurance in U.S. companies, and does not count self-employed people. The non-agricultural data is calculated by replying to various methods such as telephone, fax, and electronic data. The degree of rigor is much lower than that of the U.S. Department of Labor. Therefore, the non-agricultural data often revise the data according to QCEW. Judging from the revised data, there are many false highs in the past employment and labor data.

Of course, this does not mean that the non-agricultural data is completely distorted. Because the non-agricultural statistics will include many illegal immigrants and self-employed people, the social security of such people is already lacking, so they are not included in the data of the U.S. Department of Labor. But overall, the data released by QCEW is obviously not as strong as the previous non-farm payrolls data.

In terms of specific data, we need to wait for QCEW to issue a complete report in 2025 to compare the deviation of non-farm data from a full-year perspective. But for the Federal Reserve, perhaps the current employment data has already been suspected of "missing the time to cut interest rates", and its priority needs to be raised to avoid causing risks in another direction.

02 How will the interest rate cut path work?

Although Powell was quite hawkish in terms of the timing of the interest rate cut, he actually showed considerable mystery in terms of how to implement the interest rate cut. In his speech, Powell only mentioned that "the timing and pace of rate cuts will depend on subsequent data, changes in outlook and risk balance". Powell did not discuss the specific scale of rate cuts, target points and paths, nor did he deliberately refute the expectation of a single large rate cut (50BP). Overall, Powell's attitude towards the pace of rate cuts is rather ambiguous, and the market has made corresponding adjustments. After Powell's speech, the market's expected probability of a 50bp rate cut in September increased slightly, while the probability of a 25bp rate cut fell slightly. According to CMEFedWatch data forecasts, the current market pricing probability of a 25bp rate cut in September is 76%, the probability of a 50bp rate cut is 24%, and the probability of a 25bp rate cut in November and December is 53% and 44%, respectively. In other words, the most likely path is a 100bp rate cut this year and a 200bp rate cut in the next year.

However, it should be pointed out that in this speech, Powell did not mention the so-called "inflation target", but only said that the monetary policy review process every five years will begin later. This is the indicator that Powell has valued most in the past few years. To this day, US inflation expectations have still not reached the 2% target, and judging from the speeches of past Fed officials, the current inflation value should actually have failed to meet the Fed's expectations for rate cuts.

It's just that the times are different now. Against the backdrop of global easing and the start of a cycle of interest rate cuts in various countries, the Fed may have reached the point where it "has to cut". Therefore, in subsequent interest rate policies, inflation may not be given the same priority as in the past. But precisely because the inflation target has not yet been achieved, past policy inertia may affect the Fed's subsequent decisions. In terms of the pace of interest rate cuts, I tend to think that the Fed's interest rate cuts are discontinuous and "stop-and-go".

According to Powell's current remarks, economic data, especially employment performance, will be the key to determining the pace of interest rate cuts. The upcoming August non-agricultural data may become a key factor that significantly affects the decision to cut interest rates in September. If the employment data is higher than expected, the interest rate cut path within the year may also be lower than 100BP, fluctuating between 75BP and 50BP.

The interest rate cut in September is a foregone conclusion, but if the US inflation data rebounds significantly during September-October, and the labor market tightens further under a tight state, the Fed's determination to cut interest rates may not be able to support it to maintain its interest rate cut process. The current interest rate cut trading atmosphere in the market may also be affected. If the employment data further weakens, the probability of multiple or single large interest rate cuts within the year will increase.

03 It's a commonplace, what is the impact of interest rate cuts on assets?

From the current economic environment of the United States, its economic resilience is still there, and the environment is still far from a deep recession. The main purpose of the decision to cut interest rates is to curb the further deterioration of employment data. Therefore, this interest rate cut can be regarded as a so-called "preventive interest rate cut". Referring to the history of interest rate cuts by the Federal Reserve since 1984, such interest rate cuts are often not too radical in pace, and the initial progress is controllable, but the overall interest rate cut may have a deeper depth depending on the changes in the economic environment.

If you look at it from a short-term perspective, preventive interest rate cuts often have a positive effect on assets such as US stocks, US bonds, and gold. The liquidity released by the interest rate cut will stimulate the allocation scale of such assets to varying degrees. But as mentioned in previous articles, interest rate cuts often have an early response. Judging from the trend of US stocks and gold since July, this kind of "preemptive run" is quite obvious. Therefore, in the month of interest rate cut, we need to pay attention to certain callback risks.

However, as far as the trend of gold is concerned, its price obviously has more supporting factors. In my past judgment, gold may fluctuate at a high level below 2,500 points this year. But the actual gold price broke the $2,500 mark a few days ago, and once rose to $2,531. Between July and August, the situation in the Middle East and the conflict between Ukraine and Russia have deteriorated to varying degrees. I believe this is the main reason for the upward trend of gold prices. As for the stimulus of interest rate cuts to gold prices, I still believe that it has been responded to in the market, and the expectation of gold price increase after the interest rate cut is still not too high.

From a long-term perspective, equity assets and gold can often obtain relatively good positive returns and average returns in the liquidity easing brought about by interest rate cuts. Commodity prices and crude oil prices, which are closely tied to the real economy, often face pressure during interest rate cut cycles. At the same time, interest rate cuts in the US market often lead to active global liquidity, and emerging markets in Asia may benefit from it.

However, the start of the US dollar interest rate cut cycle does not mean that the liquidity of the domestic market will be quickly corrected and improved. Especially in the context of tense Sino-US competition and asynchronous economic cycles, it should be considered that liquidity from the Americas will be blocked due to other factors. To evaluate the direction of Chinese assets, we must ultimately focus on China's own fundamental improvements.