At the Jackson Hole Global Central Bank Annual Symposium, Federal Reserve Chairman Powell clearly indicated that the meeting in September would see an interest rate cut, stating that "the time for policy adjustment has come."

Starting from March 17, 2022, the Federal Reserve initiated interest rate hikes to combat the high inflation following the pandemic, accumulating over 500 basis points (BP) in total. Now, the Federal Reserve's preferred inflation indicator—core PCE—has decreased year-on-year to 2.6% (close to the 2% target), and the unemployment rate has risen from 3.7% at the beginning of the year to 4.3%, sparking concerns about a recession. Goldman Sachs believes that the Federal Reserve will cut rates by 25BP at each of the September, November, and December meetings. If the August employment report is weaker than that of July, a 50BP rate cut may occur in September.

This shift has far-reaching implications for the stock, bond, and currency markets. The US dollar index accelerated its decline in August, breaking below the 101 mark after the Jackson Hole meeting, after reaching a new high for the year on June 28; Asian currencies, including the renminbi, may be boosted. In the absence of a recession, rate cuts are also beneficial for the stock market, with expectations that the US stock market will continue to set new highs, and US Treasuries may also be boosted by the rate cuts. From 1989 to the present, in the six interest rate cut cycles of the Federal Reserve (1989, 1995, 1998, 2001, 2007, 2019), looking at the average performance of stocks and bonds in the first year after the rate cuts, the Nasdaq Composite rose by 9.7%, the S&P 500 by 5.8%, the total return on US Treasury bonds by 6.2%, and the total return on US aggregate bonds by 5.7%.

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Powell Sends Clear Rate Cut Signal

Powell was no longer ambiguous this time, leading to a rapid decline in the US dollar and US Treasury yields. The US interest rate market expects a 100BP rate cut by the end of 2024, and another rate cut of slightly over 100BP in 2025.

"The 2024 pricing implies that the market believes that in the next three FOMC meetings, there is a possibility of a 50BP rate cut. We do not think there will be a 50BP rate cut in September, but if the economy continues to weaken, the issue of whether the Federal Reserve is lagging behind the economic situation will be mentioned more frequently. We believe that the Federal Reserve can convey sufficient dovish messages by cutting rates by 25BP and promising to accelerate the easing pace when economic data significantly deteriorates. This approach allows the Federal Reserve to maintain flexibility while easing policy and avoid sending a message of significant concern about the US economic outlook," said Eric Roberten, Global Chief Strategist at Standard Chartered, to reporters.

Powell did not specify the magnitude of the rate cut, but stated that "the timing and pace of rate cuts will depend on upcoming data, the evolving outlook, and the balance of risks."

Regarding inflation, Powell said that "the upside risks to inflation have diminished," and his confidence that "inflation is returning to a sustainable path towards 2%" has strengthened.

"His remarks differ from the more cautious stance on inflation recently expressed by some Federal Reserve officials, which we interpret as him believing that the Federal Reserve should no longer be constrained by inflation concerns," said Goldman Sachs.

Powell also more clearly emphasized that the Federal Reserve's tolerance for a cooling labor market has reached its limit, and any further weakness is "unwelcome." He described the rise in the unemployment rate as "almost one percentage point," rather than mentioning the smaller increase on a three-month average, and pointed out that "the downside risks to employment have increased." He also stated twice that "the buoyancy of the labor market is now lower than before the pandemic in 2019—when inflation was below 2%."The institution believes that this implies that in the current two major legal mandates, maintaining price stability will be secondary to ensuring full employment. Previously, the Federal Reserve considered some softness in the job market as a necessary cost to combat inflation. However, as the unemployment rate begins to rise, the Federal Reserve's tolerance for a slowdown in employment is decreasing.

The July non-farm data showed that the unemployment rate unexpectedly rose to 4.3% (previously 4.1%), the highest point in nearly three years, triggering the "Sam Rule" with a 100% accurate rate of predicting recessions; on August 14, the overall CPI growth rate in the United States for July was announced to have dropped to 2.9% year-on-year, below the previous value and expected 3%, falling for four consecutive months, and for the first time since March 2021, it broke below 3%.

However, Powell also pointed out that the rise in the unemployment rate was driven by a "significant increase in labor supply" rather than an "increase in layoffs," and although the hiring pace is no longer "frenetic," it remains "solid."

"Soft landing" is favorable for stock and bond assets.

In the context of avoiding a recession, the Federal Reserve's corrective interest rate cuts are the most beneficial scenario for risk assets, and the rate cuts will also be favorable for the bond market.

Zeng Shaok, the head of fund distribution for Asia (excluding Japan) at Pictet Asset Management, recently told Yicai: "Our team found that in the six major interest rate cut phases in 1989, 1995, 1998, 2001, 2007, and 2019, both stocks and bonds generally benefited. Although there were years when both stocks and bonds fell, and years when bonds fell while stocks rose, overall, both stocks and bonds had a relatively good performance."

Currently, U.S. stocks have rebounded close to their historical highs, sweeping away the gloom of the global panic selling at the beginning of August. The S&P 500 index closed at 5,634.61 points on August 24, approaching the previous high of 5,669.67 points.

The expectation for U.S. stocks to set new historical highs in the short term remains high, and small and mid-cap stocks, which are more sensitive to interest rate changes, have rebounded significantly. This means that even if the momentum of the "technology seven giants" slows down, U.S. stocks may be driven by other broader stocks to contribute to the gains.

Goldman Sachs stated that hedge funds and mutual funds continue to maintain a long position in U.S. stocks, with the cash balance of mutual funds as a percentage of assets falling to a new low of 1.4%, and the net leverage ratio of hedge funds at 72%, higher than the highest level in the past five years. In addition, at the beginning of the third quarter, both reduced their exposure to technology giants, and for the first time since 2022, hedge funds reduced their holdings in the "technology seven giants" in their long investment portfolios. At the same time, both increased their investment in the healthcare industry, providing defensive and growth opportunities outside the AI sector.

U.S. Treasury yields have fallen rapidly, with the two-year U.S. Treasury yield at 3.909%, and the ten-year U.S. Treasury yield at 3.795%, both of which had once exceeded 5% at their highest points last year. This also means that the bond market has declined ahead of policy interest rates.Morgan Asset Management's Senior Global Market Strategist for China, Zhu Chaoping, told reporters that after the future interest rate cuts are initiated, short-end U.S. Treasury yields will decline more rapidly, while the forecast range for long-end yields (10-year) may be around 3.2% to 3.5%. After falling to this range, it may pause, as long-term bond yields are investors' expectations for the potential economic growth rate and long-term inflation in the United States, but the short-end is closely linked to changes in the federal funds rate. Therefore, the yield curve may end the inversion that has lasted for more than 40 months and reappear with a positive term spread.

The weakening of the U.S. dollar boosts gold prices and Asian currency markets.

The trend of the U.S. dollar will be crucial for major assets. As of the latest closing, the U.S. Dollar Index was at 100.6, down nearly 5% from its recent high.

Robertson mentioned to reporters that the decline in U.S. Treasury yields has put significant downward pressure on the U.S. dollar. However, the continuous depreciation of the U.S. dollar may require the Federal Reserve to make substantial interest rate cuts, while the United States avoids falling into a recession. The U.S. stock market seems to assume a soft landing scenario, with major indices close to their highs. However, the obvious weakening of economic momentum may cause stock market benchmark indices to give back recent gains, and the U.S. Dollar Index will also rise accordingly.

In the short term, the U.S. dollar is more likely to weaken, and future changes may have to wait until after the U.S. election. Currently, institutions are particularly optimistic about gold. After three attempts, the spot price of gold has finally broken through $2,500 per ounce, and interest rate cuts may push gold prices to new highs again.

UBS said it will continue to be bullish on gold, expecting the price to rise to $2,600 per ounce by the end of this year, and further to $2,700 per ounce by next June. The institution believes that gold can effectively hedge against geopolitical, inflation, and excessive deficit risks.

In addition, a weaker U.S. dollar is also conducive to the return of funds to the Asia-Pacific market. In the past week, the MSCI Asia ex-Japan Index (MXAPJ) rose by 1%, with India, ASEAN region, and Taiwan attracting a total of $1.1 billion in foreign capital inflows, while South Korea saw a slight outflow of funds.

Robertson said that under a weak U.S. dollar, Asian currencies have performed well since July 1, especially the Japanese yen leading the rise, and the appreciation of the Malaysian ringgit, Thai baht, and Indonesian rupiah has also contributed to the weakening of the U.S. dollar. Asian low-interest-rate currencies generally appreciate against the U.S. dollar, and the Thai baht may be one of the lowest-yielding currencies in Asia, but this has not hindered its foreign exchange performance. In the future, Asian currencies may outperform the overall emerging markets, as external pressures ease and Asian monetary policy may become more accommodative, which will be beneficial to economic growth.

This also means that the Chinese yuan, as one of the Asian low-interest-rate currencies, may continue to benefit from the weakening of the U.S. dollar, and the current depreciation expectations of the yuan have begun to reverse. As of the close, the U.S. dollar/yuan was reported at 7.1244, and the U.S. dollar/ offshore yuan was reported at 7.116, with the yuan appreciating by nearly 2,000 points from its weakest level of the year.

Several traders told reporters that the unwinding of yen carry trades has driven the surge in the yen, leading to the appreciation of the yuan, which is also a low-interest-rate currency, and the settlement of foreign trade may have also intensified the rise in the yuan. Traders expect that the correlation between the offshore yuan and the U.S. Dollar Index will return in the future, and the trend of the 10-year U.S. Treasury yield is crucial.