Introduction
In the context of the constantly changing global economic landscape, the monetary policy direction of the Federal Reserve is closely watched by global financial markets. In September 2024, the Federal Reserve made its first rate cut since 2020, marking the start of a new easing cycle.
TechFlow 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, starting from the basic economic theory, analyzes the relationship between key economic indicators such as interest rates, inflation, and employment, using the latest data and historical experience. It also provides a comprehensive analysis of the performance of different asset classes, including stocks, bonds, commodities, and cryptocurrencies, during the easing cycle, offering clear decision-making references for investors.
TechFlow has summarized the key information from the report, as follows.
Key Points
· 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 the "dual mandate" principle, aiming to promote maximum employment and maintain price stability (2% inflation target). In mid-2022, inflation briefly exceeded 9%, prompting the Federal Reserve to take aggressive rate hike measures, raising rates to the highest level in 20 years. As inflation gradually cools, the Federal Reserve has initiated a new easing cycle.
· Interest Rate Impact Mechanism: Interest rates, as the "price of money," affect the market through two main channels:
- Reducing borrowing costs, making it easier for market participants to obtain funds and reducing the debt burden of existing debt
- Lowering the risk-free rate of return, prompting investors to seek other investment channels to increase returns
· Historical Trend: 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 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
- The relationship between commodities and interest rates is more complex, affected by factors such as inventory costs, lack of yield, and exchange rates
- Bond prices and interest rates have an inverse relationship
- Although historical data on cryptocurrencies is limited, they have performed strongly during easing cycles, such as a 537% increase in the 12 months following the March 2020 rate cut
Policy Shift: The Global Central Bank Easing 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%, the first rate cut since March 2020 in response to the COVID-19 pandemic. Prior to this, to address rising inflation, the Federal Reserve had aggressively raised rates from March 2022 to July 2023, and then maintained rates unchanged for eight consecutive meetings until this latest cut. The 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 briefly exceeding 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 begun to shift towards easing. The current market expects 1-1.5 percentage points of rate cuts in 2025, with a 62% probability of a 0.25% cut in December (a 38% probability of maintaining the status quo).
The complex relationships between inflation, rate cuts, and the broader economic system (including asset performance) are worth close attention by market participants.
It is worth noting that in 2024, multiple central banks around the world have already initiated rate cut processes, a trend that will have a profound impact on global financial markets.
Basic 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 economic operations.
The Fundamentals of Interest Rates
• Core Definition: Interest rates are essentially the "price of money"
Higher interest rates = Money is more expensive
Lower interest rates = Money is cheaper
Two Major Impacts of the Current Easing Environment
1. Debt and Borrowing Effect
· Businesses and institutions can obtain financing at a lower cost, promoting investment expansion
· The interest burden of existing debt is reduced, improving cash flow
· Consumers' borrowing costs decrease, stimulating consumption and housing demand
· Overall economic activity is boosted, supporting economic growth
2. Yield Effect
· The yield on risk-free assets such as government bonds decreases
· Investors are forced to seek other investment channels to achieve higher returns
· Valuations of risky assets such as stocks and real estate are supported
· Capital flows from low-risk assets to high-risk assets
Key Economic Variables
1. Inflation
· The Federal Reserve has set a long-term target inflation rate of 2%
· Inflation briefly exceeded 9% in mid-2022
2. Employment Situation
· The current unemployment rate is maintained at a relatively healthy level of 4.1%
· Nonfarm payroll data, released on the first Friday of each month, is an important market indicator
3. Market Environment and External Factors
· Corporate Earnings: Quarterly reports and expectations are a barometer of market sentiment
· Regulatory Policies: Attitudes towards financial innovations, including cryptocurrencies (as shown in the figure below, the number of crypto-friendly individuals in the House and Senate has increased significantly in the U.S. elections)
· Geopolitics: External shocks such as international trade relations and regional conflicts
· Macroeconomic Indicators: Including trade balance, consumer confidence, PMI, and others
Historical Perspective: Past Federal Reserve Easing 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: Near-zero rate levels
· Recently: Risen above 5%
· September and November 2024: Initiation of a new easing cycle
Historical Performance of Various Asset Classes
1. Stock Market (S&P 500)
· Overall Trend: Generally rising after rate cuts
Specific Performance:
September 1984 first rate cut: +1% in 3 months, +9% in 6 months, +14% in 12 months
Interest rate cut in July 1995: 3 months +6%, 6 months +13%, 12 months +22%
Special cases: Negative returns appeared in 2001 and 2007 (economic recession periods)
January 2001: 12 months -12%
September 2007: 12 months -18%
2. Commodities
· Influencing factors:
Inventory cost: Interest rate affects holding cost
Yield 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
3. Bonds
· Core characteristics: Inversely related to interest rates
· Operating mechanism:
-Interest rate rise → Bond price fall
-Interest rate fall → Bond price rise
10-year Treasury yield: Highly correlated with the federal funds rate
4. Cryptocurrencies
· Historical data: Only experienced two interest 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:
-Short sample period
-Relatively small market size, high volatility
-Affected by multiple factors, not just interest rate changes
This historical review shows that while interest rate cuts usually provide support for asset prices, the specific performance varies by asset class and macroeconomic environment. Particularly during economic recessions, even interest 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 interest rates are cut or not.
Conclusion: The global interest rate cut cycle has begun, with both opportunities and challenges in the market
As the report shows, September 2024 has become the fourth largest interest rate cut month of the century, with 26 central banks implementing interest 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 interest rate cuts in September and November not only have far-reaching implications, but also foreshadow the possibility of even greater policy easing in 2025.
Based on historical experience, interest rate cut cycles often lower the cost of capital, improve market liquidity conditions, and provide support for asset prices. However, this round of interest rate cut cycle has its own uniqueness: global inflation has clearly retreated from its 2022 peak, but the risk of inflation rebound still needs to be watched; the job market remains relatively stable, with the unemployment rate maintained at a healthy level of 4.1%; geopolitical tensions also add additional uncertainty.
Looking ahead to 2025, the market generally expects the Federal Reserve to further cut interest 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 investors need to seize the opportunities, they also need to remain clear-headed: different asset classes may exhibit differentiated performance during the interest rate cut cycle, and simply following the interest 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 deploy cautiously to better adapt to this new market environment.
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