The impact of successive Fed rate cuts on asset prices

Recent US inflation data continues to fall, high-frequency economic data is weakening marginally, and the market generally expects the Fed to start cutting interest rates in September. Looking ahead to the second half of the year, the Fed's interest rate cuts will be a key factor affecting the global asset price trend. Drawing lessons from history, what are the rules for the way and pace of Fed interest rate cuts in history? How do global asset prices perform during interest rate cut cycles? This article will analyze this.

1. Relief-style interest rate cuts: Policy measures taken to deal with sudden shocks

Since 1982, the Fed has conducted 4 relief-style interest rate cuts and 5 preventive interest rate cuts. Depending on the purpose of the interest rate cut, Fed interest rate cuts can be divided into relief-style interest rate cuts and preventive interest rate cuts. The main difference between the two lies in whether the US economy has entered a recession at the time of the interest rate cut. The former often occurs after a clear recession in the economy and is used to stimulate the economy, while the latter is common when a recession has not yet occurred, aiming to prevent the risk of recession.

So how can we quantitatively judge whether the US economy is in a recession? There are three commonly used methods: ① NBER recession interval: The National Bureau of Economic Research (NBER) in the United States is the authoritative institution defining the economic cycle in the US. It determines the recession interval by considering six indicators such as personal real income after deducting transfer payments, non-farm employment, etc. ② Sahm Rule recession index: Economist Claudia Sahm proposed the Sahm Rule, which indicates that when the Sahm Rule recession index (3-month moving average of the unemployment rate - previous year's low point) exceeds 0.5%, the economy is experiencing a recession. ③ Custom recession index: Considering that the Fed's monetary policy goal is to achieve full employment and maintain price stability, the economic recession situation is evaluated through four indicators: GDP quarter-on-quarter annualized rate, manufacturing PMI, core PCE, and unemployment rate. Based on the above judgment methods and the trend of the federal funds rate, the Fed has conducted 4 relief-style interest rate cuts and 5 preventive interest rate cuts since 1982.

Relief-style interest rate cuts: Commonly seen after regional/global crises, with large interest rate cuts and long durations. Since 1982, the Fed has conducted 4 relief-style interest rate cuts, each corresponding to major regional/global crisis events. Because these crisis events are often sudden and have a wide and deep impact, relief-style interest rate cuts have larger magnitudes, more frequent occurrences, and longer durations (see Table 1 for details). The following sections will provide a detailed review of the macro background, interest rate cut pace, and effects of each relief-style interest rate cut At the same time, the economy gradually fell into recession, with the US manufacturing PMI dropping from 50% in April 1990 to a low of 39.2% in January 1991. To mitigate the impact of the credit crisis on the economy, the Federal Reserve began cutting interest rates in June 1989, conducting 24 rate cuts over the following 40 months, with a cumulative reduction of 681 basis points. In terms of the effectiveness of rate cuts, economic indicators soon rebounded, with the manufacturing PMI trending up from 1991 to 1994.

Rate cuts starting in 2001 were aimed at addressing the comprehensive economic recession caused by the bursting of the dot-com bubble. In 2000, the US capital market was impacted by the bursting of the internet bubble, leading to the bankruptcy and closure of a large number of internet companies, plunging the economy into recession. Our custom recession index shows that US economic data deteriorated from the end of 1999, with key indicators such as GDP, PMI, and unemployment rate all showing significant declines. To overcome the impact of the bubble burst, promote economic recovery and the development of emerging industries, and alleviate the panic triggered by the "911" terrorist attacks in 2001, the Federal Reserve announced a reduction in the federal funds target rate on January 3, 2001. After experiencing 13 rate cuts over 30 months, with a cumulative reduction of 550 basis points, the policy rate eventually dropped to around 1%, much lower than the rate levels during previous periods of loose policy. In this environment, the US economy returned to a growth trajectory starting in 2002, with PMI leading the rebound and the unemployment rate gradually improving from the second half of 2003.

Rate cuts starting in 2007 were aimed at helping the US economy recover from the shadows of the recession after the financial crisis. In 2007, the subprime mortgage crisis in the US gradually emerged, with the default rate on subprime mortgages rising continuously. Subsequently, the crisis spread to other markets such as bonds and stocks, with the Dow Jones Industrial Average experiencing a maximum decline of 53.8% from September 2007 to June 2009. Meanwhile, as the US economy took a sharp turn, the unemployment rate rose to 10%, and most of the manufacturing PMI from 2008 to 2009 was below the 50% threshold. Against this backdrop, the Federal Reserve made emergency rate cuts in September 2007 and continued to cut rates 10 times thereafter, lowering rates by 550 basis points to an ultra-low level of 0.25% by the end of 2008. However, rate cuts alone were insufficient to address the severe economic situation, prompting the Federal Reserve to introduce quantitative easing (QE) for the first time, using unconventional monetary policy tools such as large-scale purchases of US treasuries and mortgage-backed securities to lower long-term interest rates, stimulate the economy, and inject liquidity into the market. With the combined effects of rate cuts and QE, the US economy emerged from the recession, with manufacturing PMI and GDP showing signs of recovery in the second half of 2009

The focus of the interest rate cuts in 2020 was to address the severe impact of the COVID-19 outbreak on the U.S. economy. With the outbreak of the COVID-19 at the beginning of 2020, the global economy suffered a huge impact, and various countries introduced epidemic prevention and control measures, including some restrictive measures that had negative impacts on production and consumption. In this situation, the U.S. economy suffered a severe blow in a short period of time, with the manufacturing PMI falling from 50.9% in January 2020 to 41.5% in April 2020. As a result, the Federal Reserve quickly made the decision to cut interest rates, and on March 3, 2020, and March 16, 2020, it cut rates by 150 basis points in two consecutive operations, bringing the interest rate down to the lowest level of 0.25%. In addition, the Federal Reserve also restarted quantitative easing policies and launched a series of emergency loan programs to support the market and alleviate the huge impact of the epidemic on the economy. Stimulated by the massive easing policies mentioned above, the U.S. economy achieved a V-shaped recovery, while the inflation level also quickly rose, with the CPI continuously increasing year-on-year from June 2020.

2. Preemptive Rate Cuts: Policy Preparation in the Face of Adverse Factors

The previous section mainly reviewed the macro background, rate cut pace, and effects of each relief rate cut cycle by the Federal Reserve. Unlike relief rate cuts, the purpose of preemptive rate cuts is to guard against the risk of an economic recession that has not yet occurred, that is, the economy has not entered a recession. Preemptive rate cuts usually occur under what kind of economic background, with what magnitude and frequency of rate cuts? The following section will analyze this in detail.

Preemptive rate cuts: They often occur when economic indicators show a slowing trend, with small rate cuts and short durations. Since 1982, the Federal Reserve has conducted a total of 5 relief rate cuts. Usually, at this time, the growth rate of certain economic indicators shows a slowing or declining trend, prompting the Federal Reserve to cut rates to prevent risks. The specific reasons triggering preemptive rate cuts are diverse. In terms of the pace of rate cuts, compared to relief rate cuts, preemptive rate cuts have smaller magnitudes, shorter durations, and fewer rate cuts (see Table 2 for details). The following section will provide a detailed review of the macro background, rate cut pace, and effects of each preemptive rate cut.

The rate cut in 1984 aimed to prevent exchange rate fluctuations caused by high deficits and a strong U.S. dollar, which could impact the economy. Since the Reagan administration took office in 1981, it had been implementing loose fiscal policies, driving the prosperity of the U.S. economy. However, the fiscal deficit continued to expand, reaching 6.1% of GDP by 1984, at a historically high level. At the same time, against the backdrop of a strong U.S. dollar, the trade deficit continued to increase, with the U.S. net exports of goods and services exceeding $100 billion for the first time in 1984Q1. The Federal Reserve believed that the development model of loose fiscal policies and high deficits at that time was unsustainable, and with the U.S. dollar being too strong, combined with signs of slowing economic growth, in order to prevent the risk of domestic economic fluctuations caused by potential exchange rate declines in the future, the Federal Reserve began a rate cut cycle in September 1984 Within the following 23 months, interest rates were cut a total of 17 times, with a total rate cut of about 560 basis points. From the perspective of interest rate cuts, the excessively strong US dollar was suppressed after this rate cut, and the trend of expanding trade deficits gradually slowed down, leading to an overall stable economic growth situation.

The interest rate cuts initiated in 1987 were mainly to prevent the pessimistic sentiment of "Black Monday" from spilling over to the real economy. In 1987, the fundamentals of the US economy were stable. From indicators such as GDP and PMI, during the period from September 1986 to September 1987, the US GDP quarter-on-quarter annualized growth rate reached 3.4%, and the US manufacturing PMI also remained above the boom-bust line. Although the economy did not show any problems, due to excessive previous stock price increases, coupled with news of trade deficits exceeding expectations, a decline in the US dollar, etc., intensified investors' pessimistic expectations for the future economy, ultimately leading to a sharp decline in US stocks in mid-October. Especially on October 19, 1987, known as "Black Monday," the Dow Jones Industrial Average fell by over 20% in a single day. To prevent the stock market decline from spilling over to the real economy, the Federal Reserve decided to release liquidity to the market through the purchase of government bonds, initiating the first interest rate cut in November 1987, followed by three consecutive rate cuts in the next 3 months, with a cumulative cut of 81 basis points. From the perspective of interest rate cuts, the Dow Jones Index gradually stabilized and rebounded, and the US real economy did not experience significant fluctuations.

The interest rate cut in 1995 was to prepare for an economic "soft landing" in response to signs of economic growth fatigue. In 1995, there were signs of a slowdown in the pace of US economic growth. A Federal Reserve spokesperson mentioned: "Consumer spending is still weak, and the growth rate of fixed asset investment by manufacturers has slowed significantly over the past few quarters. With the decline in end sales, manufacturers are controlling inventory through production and hiring suppression." In particular, looking at two indicators, the unemployment rate and PMI: in 1995, the US added non-farm payroll numbers remained low, with only 1.201 million added from January to July, a 47.4% decrease year-on-year; the manufacturing PMI has been declining since early 1995, reaching 45.9% in June, below the boom-bust line level. The Federal Reserve believed that although the economy had not yet entered a recession, the decline in some economic indicators or implied risks of future economic downturn, thus deciding to initiate interest rate cuts to stimulate the economy and prevent a recession. This interest rate cut started in July 1995, lasted for 7 months, with a cut of 75 basis points. With the support of monetary policy, the US economy achieved a "soft landing," and the previously weak employment and manufacturing PMI indicators rebounded before the rate cut.

The interest rate cut in 1998 was mainly to prevent the spread of the Asian financial crisis and the potential recession risks it may cause. The outbreak of the Asian financial crisis in 1997 led to an economic recession in Asia, weakening external demand and directly impacting U.S. commodity trade. Although the overall U.S. economy remained stable, starting from February 1998, the U.S. export of goods to Asia showed consecutive year-on-year negative growth, with a further decline of 19.7% year-on-year by August 1998. Furthermore, the weakness in commodity trade put pressure on U.S. manufacturing companies, with the manufacturing PMI staying below the expansion-contraction line since June 1998. In addition, the Asian financial crisis triggered risks for a series of financial institutions, such as the bankruptcy of Long-Term Capital Management (LTCM), with the liquidation of its positions posing risks of further financial turmoil. To prevent the crisis from further affecting the U.S. economy, the Federal Reserve initiated interest rate cuts in September 1998, and subsequently cut interest rates three times within the following 2 months, with a cumulative reduction of 75 basis points. Through the timely intervention of the Federal Reserve, various economic indicators in the U.S. stabilized overall, and the previously declining manufacturing PMI returned above the expansion-contraction line in early 1999.

The interest rate cut in 2019 was to prevent the risks of economic recession that could arise from weakening domestic and external demand. In 2019, the overall U.S. economy maintained stable growth, but influenced by factors such as geopolitical conflicts, U.S. external demand weakened. From January to August 2019 before the interest rate cut, the cumulative U.S. export amount was about 170 million U.S. dollars, with a year-on-year growth of only about 0.3%. At the same time, there was a trend of slowing domestic demand, with the U.S. core PCE growing by about 1.8% year-on-year in August 2019, below the Federal Reserve's 2% target, reflecting a weakening domestic demand in the U.S. Furthermore, affected by the U.S.-China trade friction and the simultaneous contraction of domestic and external demand, there were signs of contraction in the U.S. domestic manufacturing sector, with slow growth in enterprise fixed asset investment in 2019 and a decline in the manufacturing PMI. To prevent the economy from falling into the risk of recession, the Federal Reserve initiated interest rate cuts in August 2019, and within the following 3 months, the federal funds target rate was reduced from 2.5% to 1.75%, with a total reduction of 75 basis points. Before the global outbreak of the pandemic in 2020, the overall U.S. economy was running steadily, with indicators such as manufacturing PMI and core PCE showing signs of recovery.

3. Asset Performance: Equities have a higher success rate in the preemptive interest rate cut period

In the above, we have reviewed in detail the macro background, pace, and effects of the Federal Reserve's interest rate cuts since 1982. Furthermore, how did the Federal Reserve's interest rate cuts affect the price trends of global asset classes during each interest rate cut cycle? The following will discuss the performance of equity, fixed income, foreign exchange, and commodity assets during interest rate cut cycles, aiming to provide reference for investors The Fed's interest rate cuts will significantly affect the trends of equity, fixed income, and foreign exchange assets, but the rules for commodity price fluctuations are not obvious. Observing the performance of various asset classes during 9 complete interest rate cut cycles, we can find:

① Equity assets have a higher winning rate during preventive interest rate cut periods, but are likely to fall during relief interest rate cut periods. Except for the interest rate cut cycle from 1989 to 1992, most equity assets generally rise during preventive interest rate cut periods and fall during relief interest rate cut periods. Specifically, in terms of U.S. stocks, the Dow Jones has the most intense reaction to interest rate cuts, followed by the S&P 500 and Nasdaq; in the domestic stock market, A-shares and Hong Kong stocks generally follow the trend of U.S. stocks, but A-shares have a certain degree of independence in their trend; developed markets outperform emerging markets, but during preventive interest rate cut periods, emerging markets may have greater resilience.

② Regardless of preventive/relief interest rate cuts, bond yields are likely to decrease and prices rise. Whether it is a preventive interest rate cut or a relief interest rate cut, the probability of a decline in U.S. bond yields is high; Chinese bond yields also generally decline, but the magnitude of decline is slightly smaller than that of U.S. bonds. It should be noted that due to the limited sample of Chinese government bonds experiencing the Fed's interest rate cut cycles, there may be some uncertainty in this conclusion; the correlation between German, British, Japanese bond yields and the Fed's interest rate cuts is not significant.

③ During interest rate cuts, the U.S. dollar is likely to weaken, the Japanese yen may rise, while the trends of the Chinese yuan and the euro are independent. Throughout the complete interest rate cut cycles of the Fed, the U.S. dollar index has both risen and fallen, but the probability of an uptrend is higher than a downtrend; the relationship between the RMB exchange rate and the Fed's interest rate cuts is not significant, showing a certain degree of independence in its trend; the Japanese yen exchange rate is likely to rise, but there have also been cases of depreciation in history; the euro exchange rate fluctuates, with relatively little impact from the Fed's monetary policy.

④ The relationship between commodity prices and interest rate cuts is weak, with gold showing higher average gains during relief interest rate cut periods. Throughout history, during the complete interest rate cut cycles of the Fed, gold has both risen and fallen, but the average increase in gold prices during the nine interest rate cut cycles is higher, with the increase during relief interest rate cut periods higher than during preventive interest rate cuts (it should be noted that the significant increase in gold prices from January 2001 to June 2003 may interfere with the conclusion); oil prices also fluctuate, but the average increase and decrease in prices during the nine interest rate cut cycles are significantly lower.

The winning rate of equities increases 1 month after a preventive interest rate cut, with U.S. bond yields declining after the interest rate cut, and Chinese bond yields also declining in the short term. Furthermore, reviewing the trends of various asset prices in the 9 interest rate cut cycles within 30 days, 60 days, 90 days, 120 days, 150 days, and 180 days after the first interest rate cut, we can find:

Equities: The winning rate increases 1 month after a preventive interest rate cut, and the performance of a recessionary interest rate cut is related to fundamentals. Looking at different types of interest rate cuts, if the Fed adopts a preventive interest rate cut, combined with the analysis above, the economy often shows marginal slowdown or a trend reversal at this time. Data shows that within 1 month of the Fed's first preventive interest rate cut, the increase in equity assets is usually not significant, but the probability of an increase after 1 month usually rises. This may be because preventive interest rate cuts often quickly produce positive effects, reverse signs of economic weakness, and drive stock market gains It is worth noting that the success rate of the first preventive rate cut for WIND A and CSI 300 within one month is higher. For recessionary rate cuts, we found that the stock indexes generally rose during the recessionary rate cut cycles in 1989 and 2020, while they fell in 2001 and 2007. The key behind this may lie in whether the rate cut can quickly repair the fundamentals. Specifically, after the recessionary rate cuts in 1989 and 2020, there were signs of recovery in the US manufacturing PMI, while the PMI recoveries in 2001 and 2007 were relatively weak.

Bonds: After rate cuts, US bond yields usually decline, while Chinese bond yields show short-term declines, and German and Japanese bond yields have no clear pattern. Data from previous rate cuts shows that the yield on the US 10-year Treasury bond declined in the 30, 60, and 180 days following the first rate cut, with average declines of 0.2%, 0.3%, and 0.3% respectively. It is important to note that initially, bond yields are mainly influenced by the rate cut operation and tend to decline; however, in the later stages of rate cuts, due to different economic recovery situations, yield trends can diverge. As for Chinese bonds, looking at data from the rate cut cycles in 2007, 2019, and 2020, the probability of Chinese bond yields declining within 1 month of the Fed rate cut is higher, but the subsequent trend becomes more uncertain. Regarding German, British, and Japanese bonds, historical data shows that the yields of these government bonds are not significantly related to Fed rate cuts, and there is no clear pattern in yield trends after rate cuts, indicating that their pricing is more influenced by internal factors such as domestic economic policies/situations.

Foreign Exchange: After rate cuts, the US dollar is likely to weaken, especially 4 months after the first recessionary rate cut. Reviewing past Fed rate cut cycles, the direction of the US dollar index within the first 4 months of the first rate cut is difficult to predict; however, after 4 months, there is a clear divergence in the US dollar index trends between recessionary rate cuts and preventive rate cuts, with the US dollar index weakening in 3 out of 4 recessionary rate cuts and strengthening in 3 out of 5 preventive rate cuts. In addition, looking at the change in the US dollar index over 6 months after rate cuts, the average decline during recessionary rate cut cycles is 3.5%, while the average increase during preventive rate cut cycles is 2.0%. Furthermore, the trend of the US dollar against the Chinese Yuan is similar to that of the US dollar index. Two months after the rate cut, on average, the Chinese Yuan depreciates relative to the US dollar in preventive rate cut cycles, while it appreciates in recessionary rate cut cycles.

Commodity: Gold has greater upward elasticity after relief-style interest rate cuts, while the trend of crude oil is not closely related to interest rate cuts. In terms of gold, the two relief-style interest rate cuts in 2007 and 2020 were quite special. Gold rose by over 20% within 3 months of the first rate cut, and significantly increased again 3 months after the rate cut. The possible reasons for these two increases are the continued presence of instability factors after major crisis events, which have increased the allocation value of gold as a safe-haven asset. Overall, during relief-style interest rate cuts, gold prices have relatively greater upward elasticity. In contrast, whether in a recessionary or preventive interest rate cut cycle, crude oil prices have not shown a clear pattern, indicating that crude oil prices are more influenced by factors such as supply and demand at the time.

Looking ahead, the Federal Reserve is highly likely to enter an interest rate cut cycle, combined with improving domestic fundamentals, the market center is expected to rise. Recently, US inflation has continued to ease, with signs of weakening economic data, and the market expects the Fed to start cutting rates in September. In terms of inflation, the US CPI in July was 2.9% year-on-year, down 0.1 percentage point from June, easing for four consecutive months; in terms of economic data, the US manufacturing PMI in July was 46.8%, falling for four consecutive months. In addition, on July 31, Federal Reserve Chairman Powell stated at the FOMC meeting press conference, "If we get the data we expect, the possibility of discussing a policy rate cut at the September meeting exists." Against this background, the Fed may start an interest rate cut cycle in the second half of the year. According to Fed Watch data, as of 08/16/24, the market expects the Fed to cut rates in September and three times this year. Looking ahead, Fed rate cuts will help attract long-term funds back to the A-share market.

From a fundamental perspective, the meeting set a positive tone, and with policy efforts, domestic macro and micro fundamentals are expected to improve. The Third Plenum and the Political Bureau meeting in July released signals of stabilizing growth. The Political Bureau meeting proposed to "continue to exert force on macro policies, be more forceful," and "strengthen countercyclical adjustments." With subsequent growth-stabilizing policies gradually implemented, China's macro and micro fundamentals are expected to gradually stabilize. Combined with Haitong macro forecasts, the real GDP growth rate in 24 is expected to reach 5%, and translated to the micro level of corporate profits, we expect the full-year net profit growth rate of A-shares in 24 to be close to 5%. With the catalysis of positive factors in the financial and fundamental aspects, the A-share market center may rise in the second half of the year compared to the first half.

At the industry level, advanced manufacturing may become a mid-term theme in the stock market. The 20th Third Plenum pointed out the need to "improve the system and mechanism for developing new quality productive forces according to local conditions, and improve the system that promotes deep integration of the real economy and digital economy," providing a clear direction for China's industrial reform and development in the future. In the medium term, focusing on high-level technological self-reliance, China's advanced manufacturing is expected to become an important sector leading the development of new quality productive forces. High-end manufacturing with export competitive advantages and technology manufacturing leading the development of new quality productive forces are worth paying attention to

Risk Warning: The implementation progress of the stable growth policy is lower than expected, and the domestic economic recovery is lower than expected