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When the Fed cuts interest rates is related to global asset reallocation.
On April 18, Dr. Zhou Jing, General Manager of the International Business Department of Huabao Fund, brought us a special sharing of "The Federal Reserve Delays Interest Rate Cuts! How to Lay Out in Advance?" through the WindTalk forum.
Mr. Jing Zhou, Ph.D. in Economics, has been engaged in quantitative analysis, alternative investment analysis and securities investment research at Deya Capital, Pan Pacific Securities (USA) and HSBC Securities (USA) in Austin, Texas. He is currently the assistant to the general manager and the general manager of the international business department of Huabao Fund. At present, he is managing a number of overseas funds such as Huabao Oil & Gas, American Consumption, Overseas Technology, NASDAQ Select, and Zhiyuan Mix.
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The highlights of this sharing are as follows:
One or two factors caused the U.S. economy to exceed expectations in the first quarter
Zhou Jing pointed out that there are two core reasons why U.S. economic growth remains sticky under high interest rates: the Fed's policy changes and residents' internal circulation.
First, the Fed's compromise on inflation. After the FOMC in December 2023, the Federal Reserve no longer pursued the inflation target hawkishly, basically made it clear that the end of interest rate hikes was over, and gave guidance for three interest rate cuts in 2024, exceeding market expectations, financial conditions were greatly relaxed, and the global manufacturing cycle rebounded further. The global manufacturing industry has been picking up rapidly since the end of last year, and global commodities have also started a round of rise.
Source: Huabao Fund
At the same time, mortgage rates in the U.S. have fallen since the Federal Reserve signaled to the market late last year that the rate hike cycle was over, driving home sales higher.
In addition, residents' internal circulation supports consumption. The excess savings formed by the household sector during the epidemic period have been transformed into capital flows circulating within the real economy, and consumption has been resilient by rising real wages.
Source: Huabao Fund
The tight job market has kept the wage growth rate of residents at a high level of about 4%, while inflation has fallen to about 3%, and real incomes of residents are still growing. Correspondingly, the growth rate of residents' real personal expenditure also remained at a high level of about 2%, and the consumer confidence index returned to a relatively high level since the epidemic.
Second, the resilience of inflation has caused the Fed to cut interest rates backwards
In the first three months of this year, inflation exceeded expectations in a row, which shattered Powell's previous conjecture that "CPI exceeded expectations or noise in January and February", and the market postponed the Fed's interest rate cut to September. However, the Fed pays more attention to the PCE indicator, which has a lower weighting of rent and insurance than the CPI, so it will be more modest.
Source: Huabao Fund
As the capital market delayed the Fed's interest rate cut expectations, the US financial conditions index began to tighten, and based on previous experience, the economy and inflation are expected to cool within 1-3 months. Since U.S. household and corporate balance sheets remain healthy, cooling is unlikely to lead to a recession. The U.S. economy is expected to grow at around 1.8% for the whole year, and the core PCE can fall to around 2%.
Zhou Jing pointed out that the current basic situation for the U.S. economy in 2024 is to remain strong in the first half of the year and have a soft landing in the second half of the year, laying the foundation for the Fed to cut interest rates after September. Even if there is no rate cut in September, there is a high probability of a rate cut in November. As for whether to cut interest rates 3 times or 2 times, it depends on the performance of the economy.
At the current rate, excess savings will be depleted in the second half of the year, and as immigration accelerates, the U.S. labor gap will also ease, wage growth will slow, and economic growth will have a significant decline. Therefore, in the second half of the year, it is necessary for the Fed to ease financial conditions and promote credit expansion. Otherwise, the U.S. economy is at risk of stalling. From the perspective of the political cycle, in an election year, the Fed also has an incentive to turn easing.
Third, the impact of interest rate cuts on the capital market
The Fed's interest rate cut has a direct impact on the U.S. bond market and the U.S. stock market, as well as the global capital market.
1. The inversion of U.S. Treasury interest rates will continue in the short term
At present, the 3M-10S and 2S-10S U.S. Treasury interest rates are fully inverted, which means that investors still believe that the U.S. economy is likely to go into recession. This inversion has a tendency to intensify, which means that the long-term risks to the US economy cannot be ignored, and the Fed's hawkish stance cannot be maintained for too long.
Source: Huabao Fund
If the data weakens in the next two or three months, the Fed's monetary policy will turn dovish. If the terminal rate stays between the current 5.25%-5.5%, the reasonable upper limit of the 10-year Treasury bond should be around 4.5%-4.6%, and the current level of interest rates has begun to be relatively reasonable. It is predicted that the real turn of the US debt in the 10-year should be when the US economy shows signs of recession, which needs to be verified by the subsequent US economic data. Zhou Jing predicts that the 10-year Treasury bond may fall to the 3.7-3.8% area by the end of 24, corresponding to two to three interest rate cuts by the Fed, and at the same time, the Fed will reduce its balance sheet by half this year.
2. U.S. stocks may usher in liquidity headwinds in the second quarter
U.S. stocks have pulled back in the past week, and the situation in the Middle East may have a certain impact, and the tightening of liquidity margins in the second quarter is not unrelated. In the second quarter, due to the slowdown in the tax payment of fiscal deposits and the decline in reverse repo, the liquidity inflection point may appear.
Source: Huabao Fund
If financial conditions are tight in April and May, economic data will decline in June, and market expectations will change again. Zhou Jing expects that the Fed meeting in May will clearly propose to slow down the reduction of the balance sheet, and market liquidity may improve by June.
Because the U.S. economy performed strongly in the first quarter, the U.S. stock market reported well in the first quarter, and after the quarterly report gradually came out, the logic of the U.S. stock market will switch from the denominator end to the numerator end, and the U.S. stock market has support.
Zhou Jing also said that some institutions expect the Nasdaq earnings growth rate to be 20% this year, even if there is a certain compression at the denominator end, as long as the profit expectations remain unchanged, there is still some confidence in U.S. stocks, especially technology stocks, this year.
Source: Huabao Fund
AFTER 23 AND 24 RALLIES, THE CURRENT FORWARD PE OF THE S&P 500 IS 20X (TTM 25X), WHICH IS HIGHER THAN THE 18X LEVEL OF THE PAST DECADE AND MORE THAN ONE STANDARD DEVIATION. However, the current liquidity of the U.S. capital market is no longer the same as before the epidemic, and the size of the money market fund alone is currently more than 6 trillion US dollars, and 20 times the PE is not completely unsupportable. In addition, S&P earnings may beat expectations this year, and the Fed's interest rate cut may further increase valuations.
3. U.S. stocks may rebalance periodically, and growth is still preferred in the long run
In terms of style, if the United States maintains the current high inflation and high growth, it will definitely benefit more from resource stocks.
However, in the current environment of tightening financial conditions in the United States, the growth rate of the United States economy will decline. In the second half of the year, as excess savings are depleted and the employment gap improves, the probability of a soft landing for the U.S. economy will be higher.
Zhou Jing pointed out that the U.S. economy will not overheat in the second half of the year, and growth is preferred in this situation, especially technology companies represented by AI.
If the Fed initiates a rate cut cycle, it will be a relatively long rate cut cycle, which may last two to three years, and will not be in place as the previous year. Historically, long-term assets in the interest rate cut cycle have benefited more.
Long-term assets are not limited to long-term bond assets, and growth companies are also considered long-term assets, such as some technology startups. If the Fed cuts interest rates in September, long-term assets will perform in the fourth quarter.
4. Gold bulls need to wait for US real interest rates to fall
The long-term trend of gold prices is closely related to the real interest rate of the US dollar, and gold may usher in a long-term market only when the real interest rate in the United States clearly enters a downward cycle. Zhou Jing expects that if the Fed starts cutting interest rates in the second half of 2024, US Treasury yields will fall accordingly, and gold may show a more sustained upward trend.
Source: Huabao Fund
However, if the situation in the Middle East eases, it may dampen gold's gains in the short term. Zhou Jing said that although she remains cautious about the possible volatility of gold in the short term, she is not pessimistic about the gold market from a full-year perspective.
5. The valuation of Hong Kong stocks is very attractive
Hong Kong stocks have weakened for three consecutive years and are now valued at very attractive valuations in major global markets. China's growth rate in the first quarter exceeded expectations, and there is a possibility of exceeding expectations in the second quarter, and the EPS of Hong Kong listed companies is expected to be reflected, and there is a need for valuation repair in Hong Kong stocks.
If the Fed sends a clear easing signal in the second half of the year and starts cutting interest rates in September, this may promote the return of overseas funds to the Hong Kong stock market, which will support Hong Kong stocks.
In terms of allocation strategy, Zhou Jing suggested that investors adopt a dumbbell strategy, using low-valuation, high-dividend, and low-volatility state-owned enterprises and central enterprises as the bottom position, while moderately adding some reasonably valued TMT companies, such as Tencent, Alibaba, Meituan, and Xiaomi.
Previous Review
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| 02 Gold hit a new high, how far can the market go? |
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