Binance Research Report: 2024 interest rate cut cycle is coming, a comprehensive analysis of the impact of the Fed’s policy

Author: TechFlow

Executive Summary

In the context of the ever-changing global economic landscape, the monetary policy of the Federal Reserve is closely watched by the global financial markets. In September 2024, the Federal Reserve made its first rate cut since 2020, marking the start of a new easing cycle.

Binance Research recently released a report that delves into the ins and outs of the Federal Reserve's interest rate policy, as well as its impact on the economy and various asset classes.

The report, grounded in fundamental economic theory and incorporating the latest data and historical experience, systematically analyzes the relationships between key economic indicators such as interest rates, inflation, and employment. It also provides a comprehensive analysis of the performance of different asset classes, including stocks, bonds, commodities, and cryptocurrencies, during the rate-cutting cycle, offering clear decision-making guidance for investors.

TechFlow has summarized the key information from the report, as follows.

Key Highlights

• Latest Rate Cut Dynamics: The Federal Reserve announced a 0.5% rate cut in September 2024, followed by a further 0.25% cut in November, marking the first rate cut since the COVID-19 pandemic response measures in March 2020. The market expects an additional 1-2 percentage points of rate cuts in 2025, with a 62% probability of a 0.25% cut in December.

Policy Background Analysis: The Federal Reserve is guided by its "dual mandate" of promoting maximum employment and maintaining price stability (2% inflation target). In mid-2022, inflation had surged above 9%, prompting the Federal Reserve to implement aggressive rate hikes, raising rates to the highest level in 20 years. As inflation gradually cools, the Federal Reserve has now entered a new easing cycle.

Interest Rate Impact Mechanism: Interest rates, as the "price of money," affect the market through two main channels:

• Lowering borrowing costs, making it easier for market participants to access funds and reducing the debt burden of existing debt

• Reducing the risk-free rate of return, prompting investors to seek other investment channels to improve their returns

Historical Trends: U.S. interest rates have shown a structural downward trend over the past 50 years, from 8-10% in the 1980s to near-zero levels in the 2010s, and recently back above 5%.

Asset Performance Analysis:

• The stock market (S&P 500) generally shows an upward trend after rate cuts, but may see exceptions during economic recessions

• Commodities have a more complex relationship with interest rates, influenced by factors such as inventory costs, lack of yield, and exchange rates

• Bond prices and interest rates have an inverse relationship

• Cryptocurrencies, although with limited historical data, have shown strong performance during rate-cutting cycles, such as a 537% increase in the 12 months following the March 2020 rate cut

Policy Shift: The Global Central Bank Rate-Cutting Cycle Has Begun

On September 18, 2024, the Federal Reserve lowered the target range for the federal funds rate by 0.5 percentage points to 4.75-5.00%, marking the first rate cut since the COVID-19 pandemic response in March 2020. Prior to this, the Federal Reserve had implemented a series of aggressive rate hikes from March 2022 to July 2023 to address rising inflation, followed by eight consecutive meetings of maintaining a steady rate, until this latest rate cut. The additional 0.25% cut in November further confirms the start of a new easing cycle.

The Federal Reserve's policy actions have always been guided by its dual mandate: promoting maximum employment and maintaining price stability. In the post-pandemic period, prices rose rapidly, with inflation reaching over 9% in mid-2022, prompting the Federal Reserve to launch the most aggressive rate hike cycle in 20 years, raising the target rate from 0-0.25% during the pandemic to 5.25-5.50%. As inflation gradually cools, the Federal Reserve has now shifted to a more accommodative stance. The current market expectation is for an additional 1-1.5 percentage points of rate cuts in 2025, with a 62% probability of a 0.25% cut in December (and a 38% probability of no change).

The complex relationships between inflation, rate cuts, and the broader economic system (including asset performance) warrant close attention from market participants.

It is worth noting that in 2024, multiple central banks around the world have already initiated rate-cutting processes, a trend that will have far-reaching implications for the global financial markets.

Fundamental Concepts: Interest Rates and the Economic Mechanism

Warren Buffett once said, "Interest rates drive everything in the economic universe." Let's start with the most basic concepts to understand how interest rates affect the economy.

The Fundamentals of Interest Rates

• Core Definition: Interest rates are essentially the "price of money"

• Higher interest rates = More expensive money

• Lower interest rates = Cheaper money

Two Main Effects of the Current Rate-Cutting Environment

1. Debt and Borrowing Effect

   1. Businesses and institutions can obtain financing at a lower cost, promoting investment and expansion

   2. The interest burden on existing debt is reduced, improving cash flow situations

   3. Consumers' borrowing costs decrease, stimulating consumption and housing demand

   4. Overall economic activity is boosted, supporting economic growth

2. Yield Effect

   1. Yields on government bonds and other risk-free assets decline

   2. Investors are forced to seek other investment channels to achieve higher returns

   3. Valuations of risky assets such as stocks and real estate are supported

   4. Capital flows from low-risk assets to high-risk assets

Key Economic Variables

1. Inflation

   1. The Federal Reserve has set a long-term target inflation rate of 2%

   2. Inflation had surpassed 9% in mid-2022

2. Employment Situation

   1. The current unemployment rate is maintained at a relatively healthy level of 4.1%

   2. Nonfarm payroll data, released on the first Friday of each month, is a key market indicator

3. Market Environment and External Factors

   

   1. Corporate Earnings: Quarterly reports and expectations are a barometer of market sentiment

   2. Regulatory Policies: Attitudes towards financial innovations, including cryptocurrencies (as shown in the image below, the number of crypto-friendly individuals in the House and Senate has increased significantly in the U.S. elections)

   3. Geopolitical Factors: International trade relations, regional conflicts, and other external shocks

   4. Macroeconomic Indicators: Including trade balance, consumer confidence, PMI, and others

Historical Perspective: Past Federal Reserve Rate-Cutting Cycles and Asset Performance

Interest Rate Trend

Over the past 50 years, U.S. interest rates have shown a structural downward trend:

• 1980s: Maintained at a high level of 8-10%

• 2010s: Approached zero-interest rate levels

• Recently: Risen above 5%

• September and November 2024: Marking the start of a new rate-cutting cycle

Historical Performance of Asset Classes

1. Stock Market (S&P 500)

• Overall Trend: Generally rising after rate cuts

• Specific Performance:

  

  • September 1984 rate cut: +1% in 3 months, +9% in 6 months, +14% in 12 months

  • July 1995 rate cut: +6% in 3 months, +13% in 6 months, +22% in 12 months

1. Commodities

• Influencing factors:

  • Inventory cost: Interest rates affect holding costs

  • Return characteristics: No fixed income

  • US dollar exchange rate: Commodities are mostly priced in US dollars

• Inflation correlation:

  

  • Often seen as a leading indicator of inflation

  • Commonly used as an inflation hedging tool

1. Bonds

• Core feature: Clearly inversely related to interest rates

• Operating mechanism:

  • Interest rates rise → Bond prices fall

  • Interest rates fall → Bond prices rise

• 10-year Treasury yield: Highly correlated with the federal funds rate

1. Cryptocurrencies

• Historical data: Only experienced two rate cut cycles (second half of 2019 and March 2020)

• Highlights of performance:

  • July 2019 rate cut: 12 months +25%

  • March 2020 rate cut: 12 months +537%

• Special considerations:

  • Relatively short sample period

  • Relatively small market size, high volatility

  • Influenced by multiple factors, not just interest rate changes

This historical review shows that while rate cuts usually provide support for asset prices, the specific performance varies by asset class and macroeconomic environment. Particularly during economic recessions, even rate cuts may not be able to prevent asset prices from falling, suggesting that investors need to consider multiple factors comprehensively, rather than simply making investment decisions based on whether there are rate cuts or not.

Conclusion: The global rate cut cycle has begun, with both opportunities and challenges in the market

As the report shows, September 2024 has become the fourth largest rate cut month of the century, with 26 central banks implementing rate cut policies globally. This trend continued in October and November, marking the entry of global monetary policy into a new cycle. As the most influential central bank in the world, the Federal Reserve's two rate cuts in September and November not only have far-reaching implications, but also signal the possibility of even greater policy easing in 2025.

Based on historical experience, rate cut cycles often lower the cost of capital, improve market liquidity conditions, and thus provide support for asset prices. However, this round of rate cut cycle has its own uniqueness: global inflation has clearly retreated from its 2022 peak, but the risk of a rebound in inflation still needs to be watched; the job market remains relatively stable, with the unemployment rate maintained at a healthy level of 4.1%; and geopolitical tensions add additional uncertainty.

Looking ahead to 2025, the market generally expects the Federal Reserve to further cut rates by 1-1.5 percentage points. Against this backdrop, major central banks around the world may follow the Federal Reserve's pace and further improve liquidity conditions. However, while grasping the opportunities, investors also need to remain clear-headed: different asset classes may exhibit differentiated performance during the rate cut cycle, and simply following the rate cuts may not be able to achieve the desired returns. It is recommended that investors, based on a thorough understanding of the fundamentals, focus on structural opportunities and prudently allocate, in order to better adapt to this new market environment.