How will monetary easing proceed "in three steps" within the year?

Since early September, policy uncertainty and market volatility have increased, especially around the central bank press conference and the release of US non-farm payroll data. We believe that the main themes for this week are as follows:

1. Domestically, how will the RRR cuts, interest rate cuts, and "deleveraging" be implemented by the end of the year?

2. Internationally, following the mixed non-farm payroll data, how will the Fed adjust its interest rate cut pace?

Regarding domestic policies, we are inclined to believe that all three policy tools will be utilized by the end of the year, but without overlap, with the key being the sequence.

As for international policies, our baseline prediction is that the Fed will cut rates by 25bp in each of the remaining three meetings this year, totaling 75bp for the year.

Of course, the market may have different opinions, and fluctuations in the US stock market may be inevitable. As the US presidential election enters the final sprint and presidential debates undoubtedly bring uncertainties to policies and markets.

Q: How will monetary easing progress in the year?

Entering September, the direction of monetary policy is gradually becoming clear. On one hand, the expected Fed rate cuts are becoming a reality, and the exchange rate is expected to weaken; on the other hand, the central bank has hinted to the market this week that they will "increase countercyclical adjustments and continue to focus on quantity, interest rates, and structure." The incremental policies of RRR cuts, interest rate cuts, and the potential adjustment of existing housing loan rates are all likely imminent, but the pace is expected to be gradual to avoid policy "overlap," as the central bank has historically rarely cut RRR and interest rates in the same month.

The probability of RRR cuts leading the way is higher. This is because RRR cuts are often relatively "swift" and "independent" at the decision-making level, while interest rate cuts require coordination with bank costs. Additionally, there is a medium to long-term need for liquidity replenishment, as MLF is gradually reducing, and government bond trading tools are just starting, so RRR cuts can promptly supplement the funding gap brought by government bond issuances.

Interest rate cuts and adjustments to existing mortgage rates may land "out of sync." Drawing from history, in August 2023, the 5-year LPR yielded to the adjustment of existing mortgage rates at the end of the same month. Similarly, the central bank's statement at this week's press conference that "further downward adjustments in loan and deposit rates still face certain constraints" and "reasonably grasp the strength and pace of monetary policy adjustments" may imply that adjustments to existing mortgage rates and LPR cuts may land in different months. Due to net interest margin constraints, adjustments to existing mortgage rates may not be as immediate as last year, and we believe that high existing mortgage rates in some core cities may be the first to be adjusted.

Q: How long will the slump in the US stock market continue?

The non-farm payroll data on Friday was not particularly bad, with the unemployment rate even decreasing, but the US stock market performed poorly, with the Nasdaq index falling by 2.55%, and commodities such as gold and copper also experiencing slight declines. How much longer will the current sluggish market sentiment persist? We believe that currently, besides seasonal factors, the two major uncertain variables at the macro level are still the core reasons for suppressing the performance of risk assets:

Firstly, the uncertainty about the future economy and policies in the United States may continue to suppress US stocks until at least the rate cut is implemented.

In our previous reports, we mentioned that based on the overall situation of the current job market, the Federal Reserve is more likely to continue with consecutive small rate cuts. However, the market may have more "aggressive" ideas, which is an important hidden danger for volatility.

In addition, reviewing the 8 rate-cut cycles since 1984, the impact of whether the U.S. economy will enter a recession on the trend of U.S. stocks is significant in the medium term (3-month perspective). However, in the short term, due to the unpredictable nature of the macro economy, even if the economy does not enter a recession, US stocks may not necessarily perform better. A typical example is the year 1987, when the US stock market plummeted, the Federal Reserve started cutting rates to deal with the significant market volatility, but there were no signs of an economic recession in the United States.

Secondly, the uncertainty surrounding the election is suppressing the trend of US stocks, which may become clearer after the election.

Since 1944, US stocks have on average performed better in the month after the election than in the month before the election. In the past 8 election years, the S&P 500 performed better in the month after the election than in the month before in 5 instances. In the recent two election years (2016, 2020), the performance of US stocks after the election was significantly better than before. Especially in the current tight election situation, the policy uncertainty brought by the election results will continue to suppress the performance of US stocks.

Furthermore, the fragility of the current trading structure of US stocks is also a significant reason for suppressing market performance.

At the micro trading level, starting from August, there has been a reversal in the most popular trading strategies since the beginning of the year, leading to significant market volatility. The sharp rise in US tech stocks this year and individual investors trading options have been major contributing factors to the market trends. We have seen a rapid increase in options trading volume during the downturn in early August.

Recently, the volume of US stock options trading has rebounded, reflecting a rebound since the middle to late August, with many individual investors still "bottom fishing" US stocks through options. Once there is a systematic negative development in the market (such as employment data falling short of expectations), a decline in US stocks will trigger a rapid exit of individual investors, leading to sharp fluctuations in the US stock market in the short term.

Q: Is the "Harris honeymoon period" coming to an end?

The "heat" around Harris is cooling down as the US election showdown intensifies. RealClearPolitics, a comprehensive polling website, shows that Trump's probability of winning surpassed Harris on September 2nd, with Trump leading by 2.1 percentage points as of September 6th; Polymarket website shows Trump leading Harris by 2 percentage points

In the 7 swing states, the election situation in Pennsylvania and Georgia is the most intense; Michigan and Wisconsin lean more towards the Democratic Party, while Arizona and North Carolina lean more towards the Republican Party.

However, considering the sample error in polling statistics, the current gap between the two candidates nationally and in swing states is within 5 percentage points, so it cannot be said that either side has a clear advantage. The presidential debate on September 10th may be a turning point to break the current deadlock.

Regarding the debate rules, on the evening of September 10th local time, Trump and Harris will have a 90-minute live TV debate without an audience present, and the opponent's microphone will be muted when the other is speaking. Harris had previously requested to have the microphone on throughout (to expose Trump's character flaws), but on September 5th, she agreed to the mute rule. The two may debate again in October, but there are no specific arrangements yet.

On the debate topics, it is expected to be similar to the debate between Trump and Biden on June 27th, focusing more on domestic economic policies such as inflation, corporate and individual taxes, housing, immigration, and other issues rather than emphasizing policies towards China. How Harris, lacking policy experience, will handle this is a major point of interest.

Looking further ahead, it is worth noting: 1) the vice presidential debate on October 1st; 2) if inflation rebounds, non-farm payrolls weaken significantly, and the US stock market plunges (due to reasons such as unexpected Federal Reserve policies), it will not be favorable for the ruling party.

Risk warning: Future policies falling short of expectations; unexpected changes in the domestic economic situation; geopolitical factors exceeding expectations