Global Shift: Japan, Korea Stocks Rise; Fed Cuts Impact; A-Shares Await Opening

• Article
• 2024-06-16
• 18 Comments

The era of great changes has already begun!

Early this morning, the Federal Reserve announced its first interest rate cut since 2020, lowering the benchmark interest rate by 0.5 percentage points to prevent the labor market from slowing down.

This morning, the Hong Kong Monetary Authority cut the benchmark interest rate by 50 basis points to 5.25%.

A global transformation is clearly underway.

So, how significant is the impact of the Federal Reserve's aggressive rate hike on the market?

The stock markets in Japan and South Korea opened higher, with the Nikkei 225 index rising by 1.7% at the open, SoftBank Group increasing by more than 2%, and Mitsubishi Corporation rising by more than 1%; Japanese stocks quickly lifted at the beginning of the trading day, with the Nikkei 225 index's increase expanding to 2.3%, Hitachi rising by more than 3%, Keyence and Fast Retailing increasing by more than 2%.

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South Korea's Seoul Composite Index opened up by 0.7%.

From the market perspective, although the U.S. stocks had a slight dip last night, the more noteworthy is the Japanese yen.

As expected, a 50 basis point rate cut in the U.S. dollar is a significant benefit for the yen, but today's morning trend for the yen is relatively weak, and the U.S. dollar is not as weak as imagined, and carry trade reversals have not shown their basis.

Gold and oil have instead seen a sell-off.

So, what is the logic behind this?

The political impact is also worth noting.

This is the closest time in nearly half a century that the Federal Reserve has started an easing cycle on the eve of the U.S. presidential election.

Although interest rate policies rarely remain unchanged during election years, the situation of starting a new rate-cutting phase less than 10 weeks before the election day has only happened twice before - in 1976 and 1984.

The Republican presidential candidate Donald Trump earlier this year stated that he believes the Federal Reserve might lower interest rates to help the Democrats win in the November 5th election.

Trump said last month that the president should have a say in the decisions of the Federal Reserve.

The market's unusual movement in response to the U.S. dollar's rate cut initially pleased investors.

The S&P 500, Dow Jones, and gold all hit historical highs, the Russell 2000 small-cap index rose by nearly 2%, and the U.S. dollar fell across the board.

However, the stock market and gold's gains gradually faded, the U.S. dollar rebounded from a 14-month low, and closed higher during the U.S. trading session.

The bond market, on the other hand, had foresight.

U.S. Treasury yields rose across the board, with long-term Treasury yields rising more significantly, possibly due to potential inflation concerns and a more accommodative financial environment, or because the Federal Reserve slightly raised its long-term forecast for the federal funds rate.

However, analysis suggests that the Federal Reserve's rate cut this time marks the sixth time in the past 30 years that the central bank has shifted from raising rates to cutting rates.

Typically, when the Federal Reserve starts to cut rates, it doesn't know whether it will take small measures like in 1995 and 1998 when the economy avoided recession, or whether it will start a longer series of rate cuts like in 2001 and 2007.

The Federal Reserve Board, through its "dot plot," indicated that it would cut rates by another 50 basis points by the end of this year, close to market pricing.

Individual officials' expectation matrix shows that there will be another 1 percentage point cut by the end of 2025, and another 0.5 percentage point cut by 2026.

Overall, the dot plot shows that the benchmark interest rate will drop by about 2 percentage points on the basis of Wednesday.

The Federal Reserve said that due to "greater confidence" that inflation is moving towards the central bank's 2% target, it has cut rates by half a percentage point, and is currently focusing on maintaining the health of the labor market.

Brian Jacobsen, Chief Economist at Annex Wealth Management in Menomonee Falls, Wisconsin, said: "The Federal Reserve ended the pause with a bang.

This is a strong signal that they have cut by 50 basis points and are expected to cut another 50 basis points this year."

After the market today, the reaction in U.S. stocks has gradually turned positive, with all three major U.S. stock futures rising.

Changes in interest rates around the world are also changing with the U.S. rate cut.

The Hong Kong Monetary Authority cut the benchmark interest rate by 50 basis points to 5.25%.

The Central Bank of Indonesia cut rates by a quarter of a percentage point on Wednesday.

What is more worth noting is China, as expectations for a decline in existing mortgage interest rates increase, and the time point for the LPR adjustment on September 20 is approaching, many analysts believe that the U.S. dollar rate cut is also a time window for changes in China's monetary aggregate and price.

From the market perspective, on Thursday, Asian investors will also pay attention to New Zealand's GDP, unemployment data in Australia and Hong Kong, and trade data in Malaysia.

Traders may also adjust positions before the inflation data in Japan and the interest rate decisions announced by the Bank of Japan and the People's Bank of China on Friday.

Huatai Securities believes that the expected continuous rate cuts by the Fed in the future are expected to reach 100-125bp (with 50-75 basis points remaining); the Fed's rate cut will also open up the possibility for other countries to continue to lower policy rates, including China.

The 50bp rate cut in September FOMC shows that the Fed's policy focus has shifted from reducing inflation to avoiding too rapid cooling of the job market.

It is expected that the Fed will continue to promote rate cuts in the future, with an expected 25bp cut in November and December, or possibly a 50bp cut at once, followed by a 25bp cut, depending on the economic situation; there is a certain degree of uncertainty in the rate cut in 2025, which is affected by the election results.

Looking at the dot plot, the Fed's current rate cut is still a rebalance of policy stance, so the cumulative rate cut from 2024 to 2026 is only 250bp; however, if the job market deteriorates beyond expectations, the pace of the Fed's rate cuts may be faster, and the magnitude of the rate cuts may be larger.

The Fed's start of a continuous rate cut cycle is expected to further alleviate the foreign exchange outflow pressure faced by the RMB exchange rate due to interest rate differentials, and open up domestic monetary policy space.

In addition, the Bank of Japan's interest rate meeting this Friday is also worth noting.

As the monetary policy gap between the U.S. and Japan continues to narrow, and Japan's domestic endogenous growth momentum is repaired, with wage growth exceeding expectations, this means that the yen has further appreciation momentum in the medium and long term, which may also bring an appreciation expectation "spillover effect" to the RMB.

Hong Hao, Chief Economist of Si Rui Group, said that under the Fed's rate cut, the RMB exchange rate has the opportunity to appreciate, and at the same time, the depreciation expectation slows down, and funds are expected to flow back to our country.

Whether it is because the valuation of U.S. stocks is expensive, or because the returns obtained by funds staying in the United States are rapidly declining, it will lead to a decrease in the expected yield gap between China and the United States, which will increase the momentum of funds flowing back to our country.

CICC believes that the 50bp rate cut is an unconventional start, in line with CME expectations, but beyond Wall Street forecasts.

Another 50bp rate cut twice this year, with a total rate cut of 250bp, is lower than the CME futures path before the meeting, explaining the rise in interest rates.

Powell emphasized that the 50bp rate cut cannot be used as a new benchmark for extrapolation, and believes that the neutral interest rate is significantly higher than before the pandemic.

Emphasized that there is no sign of any recession, and has not yet won on the inflation issue.

The Fed saw weakness in the job market, otherwise it would not have taken the "unconventional" operation of cutting rates by 50bp at the start, but at the same time, it is also trying to create an image of "leading the market but not in a hurry."

From the market reaction, it has had some effect on safe-haven assets.

An interesting paradox is that a steeper initial slope actually slows down the subsequent rate cut path, because easing will play a role in interest rate-sensitive sectors more quickly, such as real estate.

Of course, this means that the data in the next few months is crucial, and if it can "stand firm," risk assets will perform better, and safe-haven assets will be nearing the end.

Monetary policy returns to neutrality, with the high and low points of 10-year U.S. bonds being 3.8% and 3.5% respectively.

Under the current environment, U.S. bonds and gold cannot be falsified, and there are still some holding opportunities but the short-term space is limited.

If the subsequent data confirms that the economic pressure is not great, then it should "fight and retreat"; in contrast, the more certain is the U.S. short-term bonds, the real estate chain (even pulling China's related export chain), and copper is also gradually concerned, but it is still somewhat left-sided and needs to be verified.

For the Chinese market, the main impact logic is how the external easing effect is transmitted in, that is, the domestic policy response.

Hong Kong stocks are sensitive to external liquidity, and their elasticity is greater than that of A-shares under the linked exchange rate following the rate cut.

Similarly, at the industry level, growth stocks sensitive to interest rates (biotech, tech hardware, etc.

), sectors with a high proportion of overseas U.S. dollar financing, Hong Kong local dividends, and real estate, as well as the export chain, may also benefit marginally.