Fed Cuts by 50 bps, Starts Rate-Cutting Cycle, Misaligned with Market

The most important central bank meeting of the year has come to a close, with the Federal Reserve officially starting a new round of interest rate cuts.

On September 19th, the Fed announced a 50 basis point (BP) interest rate cut, bringing the interest rate range down to 4.75%-5%, which essentially met market expectations.

However, this unconventional rate cut might merely be catching up with market expectations and the rate cuts of other central banks, rather than a preemptive aggressive move.

Fed Chairman Powell emphasized that the U.S. economy and labor market remain healthy, and the 50BP rate cut should not be seen as a pace for future cuts.

The Fed will continue to reduce its balance sheet.

The median forecast for the 2024 interest rate by Fed members is 4.4%, which is 0.7% lower than the June meeting, and the median forecast for 2025 has been adjusted down from 4.1% to 3.4%, still not meeting the market's expectation of a near 225BP rate cut.

U.S. stocks rose and then fell slightly, the U.S. dollar index did not weaken significantly, U.S. Treasury yields rebounded, and gold surged to a new historical high of $2600 after the rate cut decision was announced, but then gave up the gains and fell back to around $2559.

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It appears that the market is still smart and rational, more inclined to believe that inflation is only short-term, but whether the long-term stickiness can be eliminated remains to be seen.

In the future, geopolitical factors and the U.S. election will continue to dominate the market.

Investors should avoid the risk of being overly concentrated and focus on improving the quality and diversification of their investment portfolios.

The Fed has lowered the federal funds rate range to 4.75% to 5%.

Compared to the magnitude of the rate cut, the market is more concerned with Powell's remarks and the economic forecast outlook (SEP), especially the "dot plot" that predicts the future interest rate path.

The dot plot shows that Fed members have significantly lowered the median interest rate expectation for the end of 2024 to 4.4% (i.e., a total of 4 rate cuts or 100BP this year), lowered the rate for the end of 2025 to 3.4% (a total of 8 rate cuts or 200BP), and the terminal rate is expected to drop to 2.9% by 2026 (a total of 10 rate cuts or 250BP), but this expectation is still less than the dovish rate market, which bets on a 30% chance of a 50BP rate cut in November and a total of 5 rate cuts for the year.

The white and purple lines in the chart below represent the interest rate futures and swap markets' predictions for the interest rate path over the next few years, which are significantly lower than the Fed's green line.

From past experience, the market has the ability to force the Fed to make decisions.

Powell emphasized his confidence in inflation continuing to fall to the target level (focusing on ensuring a strong job market) at the press conference, and believes that there are currently no signs of economic recession, while also downplaying the possibility of further significant rate cuts in the future.

Therefore, some market participants believe that the first 50BP rate cut may also be the only one.

Of course, the magnitude of future rate cuts still depends on economic data, especially the unemployment rate.

In addition, Powell also mentioned that the Fed had planned to start cutting rates in July.

In fact, we believe that the market's sharp division over whether to cut rates by 25BP or 50BP this time also represents the "failure" of the Fed's meeting this week.

After all, in the era of "Fed communication as a policy tool" in the post-Bernanke era, this is the most uncertain Fed meeting ever for traders.

Before this week's meeting, there was almost no clear "leakage" or "source of information" from well-known financial journalists, which only highlights the degree of uncertainty.

I believe the Fed's decision not to cut rates in July was a mistake, and the continued deterioration of the labor market since then means that the Fed, an institution that essentially dislikes risk, may choose a "safer" 50BP rate cut in the hope of controlling the risk of a continued slowdown in new employment.

Due to Powell's remarks at the press conference, which showed confidence in the economic outlook and a tendency to adopt a steady pace of 25BP rate cuts in the future, the market's dovish expectations were suppressed, resulting in U.S. Treasury yields and the U.S. dollar index both showing a pattern of falling and then rising, with the latter closing close to the 101 level.

Non-U.S. currencies generally fell against the dollar, reflecting profit-taking.

For example, the U.S. dollar/Japanese yen remained unchanged at 142.28, retaining the possibility of further rebounding.

At the beginning of this week, the yen once surged, bringing the currency pair to below 140 against the dollar; the euro remained unchanged at 1.1119, while the pound rose to 1.3200.

The Japanese yen is the most watched.

The rebound of the U.S. dollar index has driven the U.S. dollar/Japanese yen to rebound further from its annual low, and the optimistic bullish pattern and divergence signs on the daily chart suggest that the exchange rate has room to rise further.

However, there are signs of overbought at the hourly level, and attention should be paid to the short-term adjustment risk near the channel's upper rail at 144.80.

If it can break through the adjustment channel, then pay attention to the previous high positions of 147 and 149.20.

The Bank of Japan will announce its interest rate decision on September 20th, and if it conveys a hawkish signal, it may once again suppress the exchange rate trend.

The short-term rebound momentum of the U.S. dollar/Japanese yen may be difficult to change its overall downward trend.

We expect the Bank of Japan to continue to raise interest rates in October.

Overall, the previous pricing of the foreign exchange market was relatively extreme, and the market had high expectations for rate cuts before, and priced in a cumulative rate cut of 225BP.

Before that, the pound, euro, and yen all set new annual highs against the dollar, but the Fed was more moderate this time, and the market's expectations for rate cuts were very strong before, which also led to the market taking profits at present.

It cannot be ignored that the U.S. election is coming in November, and market uncertainty will increase significantly, and it is difficult for the U.S. dollar index to go lower before the election.

There have been frequent events in the Middle East recently, and if the Democratic Party in the United States is elected, it may not be conducive to resolving conflicts, once again reflecting that the geopolitical environment is still full of risks.

The trend of gold is also closely watched.

Gold surged to a new historical high of $2600 after the rate cut decision was announced, but then gave up the gains and fell back to around $2559.

Before that, the gold price had already priced in a 50BP rate cut and a more aggressive rate cut outlook for the year, so when Powell downplayed the possibility of continuous significant rate cuts at the press conference, the gold price gave up all the intraday gains after hitting a historical high.

In the short term, the correction of gold prices may continue, with the first focus on the support at $2550, which is where the 50-day moving average is located and may have some cushion, followed by the upper edge of the previous consolidation range at $2430, and if it falls, gold prices may experience a longer adjustment period.

As for the stock market, the situation is also similar.

For example, the three major U.S. stock indexes also rose and fell during the day and eventually closed slightly lower, with the S&P 500 index at 5618.26 points, down 0.29%; the Nasdaq 100 index at 19344.49, down 0.45%.

The stock market performance in the election year is generally good, and there is no significant recession concern at present.

The combination of rate cuts and no recession will benefit the U.S. stock market.

However, before the election, market volatility may increase significantly.