Staging for deeper rate cuts & all eyes on China stimulus

Austin Or, CFA

Highlights

The continued flunking of NFP in August and sizable cutbacks of the previous two months prints risk sending US economy reeling despite the unemployment rate ticked down.

US August CPI relented to 2.5%YoY, but core CPI balked at 3.2%YoY as shelter and transportation costs spiked.

Encouraging US August retail sales (2.1%YoY) and average hourly wage (3.8%YoY) in August added confidence to the benign US economy standing.

Fed made a jumbo cut of 50bp point to 4-3/4 to 5 percent but keep QT in track to grapple with rising unemployment and slumping NFP.

Fed reaffirmed disinflation trend, stablization of unemployment rate and resilient economy sustaining 2% annual GDP growth from 2024 to 2026.

A further rate cut of 50bp within 2024 is penciled in, prompted by the palpable teetering of labor market.

Rally of inflation will be impeded due to supply expansion led by lower financing cost, softening of wage increase by dropping job openings and influx of immigrant workforce, and control of excessive liquidity by persistent QT.

Dollar is cursed and commodities (except for oil) and treasuries are blessed under the rate cut setting. 

US stock market is expected to flare higher drawing parallel with the historical no-recession rate cut bull runs.

We raised our S&P 500 forecast to 5800-6000 ending 2024 in the context of the upbeat guidance of deeper rate cuts and soft landing outlook.

In September, Hong Kong Hang Seng Index (HSI) shooted up from around 17860 to 20500, with trading volume soaring from HK$113 billion to HK$303 billion.

China’s unprecedented sitmulus package targeting to inject liquidity and encourage consumption, together with expected outflow of capital from US markets due to rate cut will revive the China and HK stock markets, gearing up for 36% and 14%-47% upsurge potentials respectively in the next 12 months.

Inflation continued to throttle back in August

US August CPI rose 2.5%YoY, in line with expectations, a significant decrease from the previous value of 2.9%, marking the fifth consecutive month of slowdown; it rose 0.2%MoM, in line with expectations and the previous value. Continued drop in merchant goods prices and moderation of service prices attribute to softer CPI. The former posted a 1.9% YoY drop, the lowest level since 2004; while the latter continued to rise 4.9% YoY, yet the increase was the slowest since 2022. US August core CPI rose 3.2%YoY, in line with expectations and the previous value, having already slowed for four consecutive months, but rose 0.3%MoM, slightly higher than the expected and previous value of 0.2%. Shelter and transport services prices took a toll on the moderation progress of the core CPI. Shelter inflation, which accounts for a third of the total inflation basket, defied slowdown expectation and increased by 0.5% MoM, while transportation services prices beat expectation, edging up 0.9% MoM.

Better-than-expected US August retail sales, enduring wage growth and robust Q2 GDP uphold US economy strength

US August retail sales slowed to 2.1%YoY from the 2.9%YoY growth in July, but still underscoring positive consumer spending trends. On contrary to the austerity of retail spending (-0.2% MoM) anticipated by the market, the retail sales edged up by 0.1%MoM, following an upwardly revised +1.1%mom surge in July. On the other hand, August wage remains unruffled, belied the inflation and shored up the retail consumption. The average hourly wage in August increased by 3.8%YoY, beating the expected rise of 3.7%, with a previous value of a 3.6% increase; edged up 0.4%MoM, also trouncing the expected rise of 0.3%. US Q2 GDP growth was revised up to 3%, outshining the 1.4% annualized growth seen in the first quarter and strengthening the benign US economy standing.

50 bp rate cut in September in response to the worrisome labor market

To grapple with rising unemployment and slumping NFP at a glacial speed amid the churning downtrend of inflation, Fed made a jumbo cut of 50bp point to 4-3/4 to 5 percent. However, it refrained from bubbling excessive liquidty by continuing reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities.

Fed maintained disinflation and soft landing views

In September FOMC, Fed predicted that inflation will return to the target level of 2% by 2026, with median core PCE inflation rates for 2024/2025/2026 at 2.6%/2.2%/2.0%, respectively. Meanwhile, the Fed maintained a soft landing viewpoint, forecasting U.S. GDP growth of 2% from 2024 to 2026, with a long-term growth rate projection remaining unchanged at 1.8%. Although the Fed tweaked the unemployment rate for 2024 from 4% to 4.4%, it submitted that unemployment rate will not rise significantly but mitigate, making forecasts for the unemployment rates in 2025 and 2026 at 4.3% and 4.2%, respectively.

Prediction

1. Inflation may rally but not excessively as rate cut boosts supply, wage increase softens and QT remains in play. 

Admittedly, as interest rate decreases, it will encourage consumer spending, home purchase and corporate hire, leading to stronger consumption, higher home and goods prices. However, the other side of the coin is that, lower rate will alleviate financing cost, driving supply expansion, favoring downstream goods and home prices and smoothing inflation. Due to the normalization of labor market post-pandemic, continued influx of immigrants and the deteroriating vacancy to unemployment ratio, the wage hike pressure is expected to deflate or flatten going forward, helping pent up inflation pressure. Moreover, Fed’s continuation of QT will partially offset the increaseed liquidity brought by lower interest rate and limit the rally of inflation.

2. Slacker dollar, higher commodities prices and more attractive treasuries.

As US interest rate is higher than G7 and China, US dollar depreciation is looming amid the new rate cut cycle as the greater rate cut room will shrink the relative interest rate diffierential of dollar. Accounting for expected weakening of US dollar and supply expansion provoked by lower rate, commodities prices (except for oil as OPEC will raise output in December) are expected to climb up. US treasuries are also the beneficiaries of rate cut, particularly the short term classes which are more sensitive to short rate cut.

3. Bull run of US stock to last.

As the current US consumption growth stays in the positive territory, and the economic activities and job market will be favored by rate cut, we reckon that the balance is tilted to soft landing side. Judging from the historical rate cut cycles when recessions were dodged in 1998, 1995, 1989, 1987 and 1984, S&P500 rose by 8%-27% 12-month after the rate cut. So, if history repeasts, we are going to see an extension of US stocks bull run. Although there ought to be some capital outflow from the US capital market to overseas due to lower interest rate and depreciation of US dollar, the higher listco earnings thanks to reduced interest cost, the AI investment wind and the capital replenishment from the money market and bank savings will provide boost to the US stock market. The latest wallstreet S&P500 forecasts for 2024 and 2025 top at 6100 and 7000 fueled by rate cut and AI bonus. Bain forecasted that the global market for AI-related hardware and software was expected to grow between 40 percent and 55 percent annually, reaching between $780 billion and $990 billion by 2027.

4. Upswing of China and HK stock markets.

China and Hong Kong stock markets will be energized due to the capital intflow from US market, together with the powerful eocnomic stimulus measures by China lately. On September 25, PBOC announced 800 billion yuan (US$114 billion) stock buying initiative to bolster China stock market, roughly equivalent to 3 per cent of the A-share market’s current total free float market capitalization, with follow-on supporting investment funding until the stock market is rejuvenated. Besides, PBOC will cut the reserve requirement ratio (RRR) by 0.5 percentage points in the near future, providing about 1 trillion yuan (about 141.82 billion U.S. dollars) in long-term liquidity to the financial market. Depending on the liquidity situation in the market, RRR may be further lowered by 0.25 to 0.5 percentage points within the year. Moreover, the central bank will reduce the interest rate of seven-day reverse repurchases from 1.7 percent to 1.5 percent, guiding the loan prime rate and deposit rate to move downward. PBOC will also put forward loosening measures to remove the impasse of housing market. The average reduction in mortgage rates for existing home loans is expected to be around 0.5 percentage points, and the nationwide minimum down payment ratio for second homes will be reduced from 25 percent to 15 percent. Additionally, China will encourage trade-ins of consumer goods boosting the purchase of new energy vehicles and smart home appliances.The monetary easing policies will inject liquidities to China and Hong Kong and trigger re-rating of China property and consumer stocks, thereby pushing up A share and HSI. Suggested by the past market performances, the room of upsurge for A share index is 36% as 1998 and that for HSI is 14%-47% as 1998, 1995, 1989, and 1987 in the next 12 months.

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