Goldman Sachs: Where are investors' biggest opportunities when the Fed cuts interest rates?

US inflation slowing down presses the "acceleration key" for global central bank rate cuts.

Nomura previously pointed out in a report that the global rate-cutting cycle is already on its way, expecting rate cuts from now until the end of June by the European Central Bank, Swiss National Bank, Bank of Canada, and National Bank of Poland, with many other central banks taking a dovish stance.

Goldman Sachs strategist Jan Hatzius stated in a research report released on May 20 that the easing cycle in the G10 is gradually expanding. Following the Swiss National Bank and the Swedish Central Bank, it is expected that the European Central Bank, Bank of England, and Bank of Canada will all start cutting rates in June this year.

The report indicates that although the growth rates of prices and wages are still above the central banks' target levels, more and more G10 central banks believe that with significant cooling of inflation risks, it is clearly necessary to adjust the high-interest rate policies.

The Fed will not cut rates first, and the number of rate cuts may exceed expectations

Hatzius stated that due to the consecutive rise in core inflation in the first quarter, the Federal Reserve will not be among the first central banks to cut rates. That is, the pace of the slowdown in US inflation is not enough to support the Fed cutting rates first.

Combining CPI, PPI, and import price estimates, we expect the month-on-month growth rate of the US core PCE price index in April to be 0.26%, slowing down from the average of 0.36% in the previous three months. However, if this growth rate continues in May and June, it may still not support the Fed's decision to cut rates in July.

However, based on the market's core PCE index (excluding sub-items such as portfolio management services and gambling), the month-on-month growth rate is only 0.18%. If this pace continues, we expect two rate cuts in July and November.

The report adds that the US PCE price index's month-on-month growth rate ranks first among G10 economies, but considering that month-on-month data is easily affected by seasonal adjustments, year-on-year data is equally important, and the current growth rate is at a moderate level among G10 economies.

However, the report also states that the US labor market is cooling down, and there are signs that the economy's better-than-expected performance may have peaked, which could lead the Fed to adopt a "more aggressive easing policy," meaning cutting rates more than twice unexpectedly this year.

The report points out that despite strong GDP growth data, the tightness of the US labor market has returned to pre-pandemic levels (with a slight increase in the unemployment rate, continued decrease in job vacancies, quit rates, and labor shortages). Coupled with a backdrop of weak sales markets, the US's subsequent economic growth may be weak.

Considering that April retail sales data fell short of expectations, we expect the US GDP growth rate to slow down from 4.1% in the second half of 2023 to 2.2% in the first half of 2024 In contrast to other G10 economies, we expect the average GDP growth rate to rebound from -0.4% in the second half of 2023 to +1.2% in the first half of 2024.

Focus on Investment Opportunities in Emerging Markets

The report indicates that regardless of when the Federal Reserve cuts interest rates, investors' greatest opportunities may arise in emerging markets, especially in Latin America, the Middle East, and Africa.

Why is a Federal Reserve rate cut beneficial for emerging markets?

The report explains that due to concerns about their domestic currencies depreciating against the US dollar, the rate cuts by central banks in emerging markets were merely "exploratory" in nature.

Furthermore, as the inflation situation in these emerging market countries has continued to improve this year, with core inflation rates in April hitting new lows both on a month-on-month and year-on-year basis, their central banks' real policy rates (excluding inflation factors) have already risen to a highly restrictive level.

Therefore, when the Federal Reserve starts cutting interest rates, the yield on US dollar assets decreases, leading capital to flow into higher-yielding emerging markets driven by a resurgence in risk appetite