On 18 September, the Fed announced after the Monetary Policy Committee FOMC meeting that the target range for the federal funds rate would be reduced by 50bp from 5.25% to 5.50% to 4.75% to 5.0%. This is the first rate cut since the Fed began its tightening cycle in March 2022.

The Fed's interest rate cut was in line with expectations, and to the surprise of some market participants, the decline was the decline. The market had fully expected a rate cut, but there was disagreement on the cut. Ahead of the Fed meeting, since last Thursday, market expectations for a more aggressive rate cut have risen significantly as senior Fed reporters from the Wall Street Journal and the Financial Times have posted articles hinting at the possibility of a 50 basis point rate cut.

Why did the Fed choose to cut interest rates by 50 basis points?

Since Fed Chair Jerome Powell signaled that he would cut rates in late August, markets have been speculating about the magnitude of the first rate cut for nearly a month. The slight increase in the month-on-month growth rate of core CPI in August suggests that core inflation is still sticky. Coupled with weak labor market data from the United States, the Fed is widely expected to cut interest rates by 25 basis points in September.

However, at the end of last week, affected by a number of foreign media reports, the market's expectations for a 50 basis point interest rate cut rose sharply. Now, the speculation that has been going on for nearly a month has finally come to a conclusion. In a press conference after the meeting, Powell explained: "It was possible to cut rates in July, but it didn't actually happen. He denied that the rate cut was too slow, and did not see it as a sign of falling behind the interest rate curve, but stressed that the rate cut was a manifestation of the Fed's commitment to "not lag behind the economic situation".

Powell has repeatedly stressed that the 50 basis point rate cut should not be seen as a new benchmark for the path of future rate cuts. He believes that the neutral rate is significantly higher than pre-pandemic levels. Given that a 50 basis point rate cut could raise concerns about the Fed's sluggishness, Powell repeatedly clarified in his post-meeting press conference that the rate cut was not a rush to action, but an appropriate response to current conditions in the job market.

In order to dispel the market's expectation of a straight line outflow of the path of interest rate cuts, Powell further noted that the Fed has not set a fixed path for interest rates. The pace of future interest rate cuts can be accelerated, slowed down, or even suspended, and everything will be decided on a case-by-case basis at each meeting.

In addition, Powell also mentioned that since the neutral rate is significantly higher than the pre-pandemic level, this means that the eventual endpoint of interest rates will also remain at a higher level.

|The Fed has two more rate cuts?

The Fed began its rate cut cycle in September, but its cautious message means that the pace and magnitude of future rate cuts remain uncertain. The dot plot released in June showed that more than half of the officials expected to cut interest rates at most once this year.

According to the dot plot updated at the September meeting, just over half of the 19 officials who provided forecasts believe that the Fed will cut rates by at least another aggregate of 50 basis points for the rest of the year. This means that a 25 basis point rate cut at each of the last two monetary policy meetings of the year is more likely. However, Powell stressed at the press conference that the dot plot projections for the federal funds rate do not represent specific policy initiatives.

In addition, the Fed updated its forecasts for the United States economy and inflation. The latest projections show that real GDP growth in the United States is expected to be 2.0% in 2024, slightly lower than the 2.1% forecast in June, while growth expectations remain unchanged at 2.0% in 2025 and 2026. On the inflation front, personal consumption expenditures (PCE) inflation is expected to be 2.3% in 2024, down from 2.6% in June, while inflation expectations for 2025 are expected to be 2.1%, also lower than the previous 2.3%, while inflation expectations for 2026 are unchanged from June at 2.0%.

What is the next path for interest rate cuts?

Despite the 50bp rate cut for the first time, a "soft landing" is the most likely scenario due to upbeat guidance and current data performance. An interesting paradox is that a larger initial rate cut could lead to a slower pace of subsequent rate cuts, as easing will work more quickly in interest-rate sensitive areas, such as the housing market.

This means that economic data in the coming months will be particularly critical. If economic data remains solid, if not significantly improved, it will reinforce the Fed's message that "rapid rate cuts are accompanied by unabated economic growth." In this case, risky assets will perform better, while safe-haven assets may be nearing the end of their lives.

In fact, although the rate has not yet been officially cut, the effects of easing are already beginning to be felt:

The real estate market is showing signs of a recovery in both volume and prices. United States second- and new home sales picked up again in July after five consecutive months of decline, as the 30-year mortgage rate fell rapidly to 6.4% along with the 10-year Treasury yield, below the average rental yield of 7%. Second-hand home sales showed positive growth for the first time in five months, while new home sales rose 10% month-on-month, showing a positive change in leading indicators.

In addition, as mortgage rates have fallen, refinancing demand has also started to pick up, with the equivalent rent (OER) in the Consumer Price Index (CPI) rising again in July after five consecutive months of decline, which is closely related to expectations in the housing market.

What the market is worried about is what will happen next?

For now, an unconventional rate cut of 50 basis points may raise concerns about increased pressure on future growth in the short term. Therefore, several economic data for the future are crucial. If the data does not deteriorate sharply, there is an improvement in rate-sensitive areas, such as real estate, which will send a combined signal to the market that the rate cut is sufficient and the economy is performing well, thus striking a new equilibrium. In this case, the main line of the market may turn to the repair trade after the rate cut.

Therefore, in the current environment, the upside of US Treasuries and gold is limited, although they may still remain unfalsified due to their holdings. If subsequent data proves that the economic pressure is not significant, these assets should be exited in due course. By contrast, it is more certain that short-term bonds benefiting from the Fed's interest rate cuts, the recovering real estate sector (and even China-related export chains), and copper prices are worth watching.

For the Chinese market, the main logic of observing the Fed's interest rate cut is how the effect of external easing is transmitted to the domestic market, that is, how domestic policy will respond in this context. Given the interest rate differential between China and the United States and the constraints of the exchange rate, the Fed's rate cut will provide China with more easing windows and conditions, which is necessary for the current weak growth environment and higher financing costs.

Therefore, if the domestic easing is greater than that of the Fed, it will give the market a bigger boost. Conversely, if the easing is limited, which is a more likely scenario under the constraints of current realities, then the impact of the Fed's rate cut on the Chinese market may be marginal and partial. Based on this perspective, Hong Kong stocks will be more resilient than A-shares because they are more sensitive to external liquidity and Hong Kong follows interest rate cuts under the linked exchange rate system.

Similarly, at the sector level, interest rate-sensitive growth stocks (such as biotechnology, technology hardware, etc.), sectors with a high proportion of overseas US dollar financing, local dividends in Hong Kong stocks and even real estate, as well as export chains related to real estate demand driven by interest rate cuts in the United States, may benefit marginally.