The Fed party finally started
The US Federal Reserve kick-started the highly anticipated rate-cutting cycle with a bang. A 50bps interest rate cut brings the Fed Funds target to 4.75-5.00%. Despite the jumbo-sized cut, we believe that it is less of a potential recessionary concern, and more a recognition that the disinflation process is well underway. We continue to forecast 25bps cuts in the upcoming November and December FOMC, followed by quarterly 25bps cuts in 2025.
Does size matter?
Unsurprisingly, investors demand faster and larger rate cuts. Fed Chair Powell recently mentioned that the Federal Reserve does not follow a preset path of rate cuts and will continue to make decisions based on incoming economic data. Markets were slightly disappointed by his less dovish than expected stance. Nonetheless, the “pivot” we were all eagerly awaiting has finally occurred. Hence even as market participants continue to bet on the size and timing of rate cuts, what is more crucial is that the direction of further monetary loosening is now clear.
Who’s already at the party?
Some consider the Fed “late” to the party, and the 50bps cut is seen as making up for lost time. The Swiss National Bank (SNB) in March 2024 implemented the first rate cut among developed economies in this cycle, while Sweden (Riksbank), Canada (BoC) and Euro Area (ECB) swiftly followed. The United Kingdom (BoE) and New Zealand (RBNZ) were the last to join the club before the Fed finally commenced their rate cutting cycle in September 2024. Amongst the developed markets’ central banks, only BoJ is moving in a different trajectory. Even so, the latest tone from the BoJ is much less hawkish, with the recent Yen volatility fresh in the minds of policymakers. All in all, the developed markets have made it clear. We are at the start of a globally synchronised monetary loosening.
Party to continue on easing inflation and labour concerns
The stubbornly hot inflation globally seems to have finally quelled sustainably. The cooling consumer prices will continue to give the Fed and other major central banks license to lower rates further. In fact, the narrative recently shifted from stubborn inflation to labour slowdown, which reignited recession fears. This is supportive for interest rates to be lower going forward, although we are less aggressive than the market in forecasting rate cuts as soft-landing in the US remains our base case.
Given that major central banks have embarked on the rate cutting cycle, both short and long-term bond yields have been dragged substantially lower since April. Bank lending standards will continue to loosen, and that should improve the global liquidity and credit conditions over the coming months.
This therefore creates an environment which will theoretically support global financial markets, in particular equities, commodities and corporate bonds (prefer higher quality) as we move into the final months of 2024.
Which asset class should outperform?
On average over the past nine cycles since 1980, US bonds (government and corporate) outperformed US equities during rate-cutting cycles. This is due to recession (6 out of 9 times), and risk-off sentiment dominated the markets.
However, in the three soft landing cases, where the Fed cut rates due to an economic slowdown with inflation under control, equities outperformed bonds. As mentioned earlier, our base case remains a soft landing scenario in the US.
Hence, we do think that equities are likely to outperform bonds for this rate cutting cycle.
Further catalyst for risk assets
The direction of looser monetary policy aided various markets and asset classes to register new all-time-highs this year. However, this rate-cutting cycle is unique compared to the past. The scars from the Covid-19 pandemic run deep, and many investors are still sitting on the sidelines. Over the last few years, the high interest rates gave no reason for market participants to take on more risk, albeit that is about to change (given the reduction in rates).
We expect a stronger risk-on sentiment, which is likely to translate into stronger outflows from money market funds and more inflows for equities and bond funds.
Aside from positioning, seasonality may well play a role in the last quarter of 2024. August and September are often the worst performing months for US equities since 1990, while Q4 is generally the best performing quarter for the year. We also have the upcoming US Presidential election, where the S&P 500 typically moves higher post election and into the following year.
China joins the party!
The Fed’s big first rate cut and recent strengthening of the RMB have given room for the PBoC to announce a bigger-than-expected monetary easing. The easing includes large magnitude rate and RRR cuts, guidance of further easing and new monetary policy tools to support stock markets. Crucially, the announcement showcased Beijing’s clear intentions to achieve 5% growth target this year and put a stop to the property and consumption slump.
The move was extremely well received by the market, given the fragile sentiment and low expectations. A short squeeze engineered by hedge funds soon evolved into something more bullish, and sentiments turn positive which trigger a further buying frenzy. As of 4 October 2024, the Hang Seng Index, Hang Seng Tech Index, MSCI China are all >30% up year-to-date.
Is the rally too fast too furious?
The Fed’s rate cutting cycle will continue to improve global liquidity, and together with a weakening USD, will benefit Hong Kong and China stocks.
Also, valuations of the HSI and CSI 300 are still relatively fair despite the massive re-rating, with HSI forward PE at 10.6x (vs 5-year average 10.9x) and the CSI 300 at 14.7x (vs 5-year average 13.8x).
Additionally, global funds positioning remains extremely underweight, even after such an unprecedented move. These suggest that the recent move may be more than just another bear market rally.
Nonetheless, China is a different kind of beast. The 3-year long downtrend is largely due to structural issues regarding the property sector and domestic demand. A large enough fiscal stimulus will be needed to revive domestic demand of the real economy. This is key for a more sustained equity market rally, and market expectation has been rising sharply. While we continue to stay positive on Chinese equities, we do expect an increase in volatility going forward.
Synchronised rate cuts
US Federal Reserve commenced their rate cutting cycle with a jumbo 50bps, while several developed countries’ central banks have already started cutting before the Fed. Importantly, the rate cutting cycle is now synchronised globally (except for Japan), and are likely to continue given the easing of inflation globally, while labour market woes are also in support of lower rates.
Conclusion
Catalyst for risk assets
Bank lending standards will continue to loosen, and that should improve the global liquidity and credit conditions. Such an environment supports global financial markets, in particular equities, commodities and corporate bonds (prefer higher quality) as we move into the final months of 2024. Reducing rates during a soft landing scenario typically allows equities to outperform bonds, while seasonality and the US elections are likely near term catalysts for equities.
China market
China loosened its monetary policy more than expected, partly thanks to the Fed’s jumbo-sized cut and weaker USD. Chinese equities surged over a period of 2 weeks and are now one of the best performing markets year-to-date. We remain positive on Chinese equities. Despite the re-rating, valuations are still fair and global positioning is still low. Sentiments are turning, but fiscal stimulus is required to sustain the upward momentum.
