Guotai Junan: aggressive interest rate cuts kicking off a conservative path in expectations

Guotai Junan released a research report stating that on September 18, 2024, the Federal Reserve announced the interest rate decision, economic forecasts, and a press conference by Powell during the September meeting. The Federal Reserve broke through its previous framework of preemptive rate cuts and employed a combination of "aggressive + preemptive" rate cuts. After starting with a 50 basis point cut, Powell provided a relatively conservative projection for rate cuts for the rest of the year, but it is expected that further aggressive rate cuts may still be possible in the future. The U.S. stock market and U.S. bonds are expected to see new investment opportunities, with short-term bonds being more impacted than stocks. Guotai Junan's main points are as follows: There are five incremental adjustments in the Federal Reserve's rate cuts. Firstly, it was the Federal Reserve's first 50 basis point rate cut, signaling a relatively aggressive start to the rate cut cycle and demonstrating a stance against recession. While meeting market expectations, the Fed is managing its expectations for future rate cuts conservatively. The dot plot suggests a total cut of 100 basis points by the end of the year, with potential 25 basis point cuts in November and December. Powell emphasized in his comments that the Fed will not rush its actions, indicating that rate cuts could come quickly, slowly, or even be paused. Secondly, the Federal Reserve further lowered its economic growth forecasts for the year, adjusted upward its unemployment rate forecasts, but still provided a "soft landing" path for economic growth. The average unemployment rate for the fourth quarter of 2024 was revised up from 4.0% to 4.4%, indicating a likelihood of further increases in the unemployment rate. Thirdly, inflation expectations were revised downwards comprehensively, making it difficult to reach the 2% target in the short term. Employment and inflation remain the dual missions in the near future. Fourth, it was mentioned that the Federal Reserve's responsibility is to support the economy, and its policy decisions will not be influenced by political or other factors, ensuring that events like the U.S. election will not disturb monetary policy. Fifth, in terms of the overall rate cut path, the Federal Reserve expects the cuts to continue until 2026, with projected cuts of 100 basis points in 2024, 2025, and 2026 respectively, stabilizing at a federal funds rate of 2.75% - 3.0%. The rate cuts are front-loaded, focusing on 2024, to prevent economic recession with a fast-paced approach. The signal is more significant than the substance, and it is expected that the Fed's accommodative period will further expand. Guotai Junan believes that the Federal Reserve's 50-basis point rate cut signals a shift towards a more accommodative policy, with a focus on the economy and employment in the short term. The Fed is expected to continue with further aggressive rate cuts. They have adjusted their view of the Fed's preemptive rate cuts compared to a slower policy path, leaning towards a preemptive and aggressive policy approach, with potential additional rate cuts of 75 basis points by the end of the year. After this meeting, the futures market for the federal funds rate reflects expectations of a 75 basis point cut. After a short-term rally and retracement in the U.S. stock and bond markets, there is expected to be further upside potential, while the U.S. dollar index is expected to decline further. The three major U.S. stock indices rallied after the rate decision announcement, but retraced after Powell's comments, closing slightly lower. Bond yields declined but rebounded, and the U.S. dollar index initially declined and then rose, mainly due to the aggressive start to rate cuts and the conservative path forecasted. It is expected that the trade-off between recession and rate cuts will continue, but the Fed's aggressive rate cuts may lead to a quicker disproval of a recession. In the short term, U.S. stocks and bonds are expected to remain volatile, with a new window for long positions in the later part of the fourth quarter. The U.S. dollar index may decline further. In the short term, the impact of loose liquidity and export stimulus is not strong, but policy space is opening up. In the short term, the effect on domestic bonds is greater than on stocks, but in the medium to long term, loose liquidity in the stock market should benefit A-share growth sectors, although it is still subject to adjustments in domestic economic expectations. The opening of the Federal Reserve's rate cut cycle will mainly impact Chinese assets through three channels: capital, policy, and exports. In the short term, the narrowing of the U.S.-China interest rate spread is limited, while export momentum slows down. Therefore, the main logic is the opening up of policy space, and further reserve requirement reductions and interest rate cuts domestically are likely to be implemented. Overall, the impact on domestic bonds is greater than on stocks. In the medium to long term, historical review suggests that the decline in U.S. bond yields boosts valuations for A-shares, particularly benefiting growth sectors, although the impact is still influenced by overall domestic economic trends. Risk warning: U.S. economic downturn exceeds expectations; bank crisis reoccurs; geopolitical conflicts intensify.