To The Moon

David Chen

Director of Investment Research

chenqingwei@itiger.com

SFC CE NO.: BUP836

Powell's speech at the Jackson Hole Economic Symposium released the most definite and affirmative attitude towards interest rate cuts. The opening statement "The time has come for policy to adjust" directly ignited market enthusiasm.

The entire speech provided two major key signals: Firstly, "The direction of inflation is very clear". With the current 3-month PCE annualized growth rate falling to 1.7%, the task of fighting inflation has basically ended, and subsequent policies will downplay the impact of inflation. Secondly, "We do not seek or welcome further cooling in labor market conditions" indicating that the Federal Reserve has officially started the next phase of the task "stabilizing the economy." At present, it seems certain that there will be an interest rate cut in September!

The market has fully priced in the interest rate cut for September, but whether the Federal Reserve can accurately predict and act to achieve a successful soft landing for the economy is still a question. The pace and path of future interest rate cuts are the most concerning issues for the current market.

1、Where is the economy heading, "landing" or "crashing"?

1.1 The market oscillates between "rate cuts trading" and "recession trading"

• The sharp deterioration of the US employment data in July led the market quickly turn to "recession trading"

Take the significant market volatility at the end of July and the beginning of August as an example. The July ISM Manufacturing PMI and non-farm employment report were both significantly lower than market expectations, leading to a rapid fermentation of expectations for a US economic recession. Subsequently, Buffett's reduction in Apple and Bank of America holdings, as well as the delay risk in the supply of Nvidia Blackwell chips due to performance issues, added fuel to the fire. The market worried that the Fed might be "behind the curve" again and quickly turned to "recession trading," with the 10-year US Treasury yield and US stocks falling sharply in the same direction.

Data Source: Bloomberg

• Subsequent data gradually stabilized, and market sentiment gradually recovered

But on the other hand, the US service PMI and initial jobless claims for July were better than expected, slightly easing market concerns about a recession, and stock prices gradually stabilized. After about a week of digestion, the market returned to rationality and moved towards "rate cuts trading," with the pricing of rate cuts in September returning to 25bp, and the S&P 500 regaining most of its previous losses. The current economy is at the last moment before the rate cuts, and future uncertainties are gradually increasing, leading to increased market volatility. In addition, the current US economy has misplaced links, with data being good and bad, causing the market to continue to swing between "rate cuts trading" and "recession trading."

1.2 Asset impact under two scenarios

• "Rate cuts trading":

  • The Fed has effectively managed the economy, relaxing restrictive interest rates at an appropriate pace and path, providing support without lifting, achieving a "soft landing" of falling inflation, stable economy, and preventive rate cuts. In this scenario, equity risk assets may perform well, especially small-cap stocks, REITs, biotech sectors, and other interest rate-sensitive targets.

  • In addition, a soft landing means that the overall economy maintains healthy growth, which will provide support for long-term interest rates. Since short-term interest rates are highly correlated with the pace of Fed rate cuts, short-term bonds are expected to outperform long-term bonds.

• "Recession trading":

  • The Fed's slow action causes excessively high interest rates to exert additional pressure on the economy, which in turn led to a rapid rise in unemployment, a sharp fall in household consumption, and negative GDP growth. As a consequence, the Fed was forced to accelerate interest rate cuts to prevent the economy from falling further. Therefore, long-term bonds and gold, which are sensitive to interest rates but not to the economy, may perform well.

  • Of course, in the event of a liquidity crisis, safe-haven assets also face the risk of being dragged down.

    Data Source: Tiger Brokers (HK) Asset Management

2、Looking ahead, a soft landing remains the baseline

2.1 The current economy shows signs of weakness, but core indicators are still solid

• The labor market appears to be weakening rather than entering a recession

Firstly, regarding the "recession trading," the July non-farm employment report that triggered market concerns was mainly affected by temporary layoffs and the high incidence of extreme weather in the season, as well as a significant increase in the unemployment rate and labor supply, reflecting the temporary labor supply friction caused by the difficulty of new immigrants finding jobs. However, labor demand is more like weakening than shrinking, and the current number of new jobs in the US job market and the ratio of jobs/workers have only returned to pre-pandemic levels.

Data Source: Goldman Sachs

Secondly, the recently released August non-farm employment report also reflects this trend: on the one hand, the number of new jobs added in June-July was revised down by 86,000, and the number of new non-farm jobs in August was 142,000, below expectations; on the other hand, average hourly wages rose by 0.4% month-on-month, exceeding expectations, and the information technology industry, which saw a negative number of new jobs, recorded a 0.9% month-on-month increase in hourly wages. At the same time, the unemployment rate in August was recorded at 4.2%, which did not deteriorate further. Overall, the employment report result was neither good nor bad, and it is still unable to prove that the economy has slid further into the abyss of recession.

• US GDP growth in the second quarter exceeded expectations, and core economic indicators are still solid

The United States raised its second-quarter GDP annualized growth rate to 3%, higher than the previous data of 2.8%. This increase is mainly related to consumption, with household consumption rising from the previous year-on-year growth of 2.3% to 2.9%, offsetting the downward adjustments for business fixed investment, residential investment, and government spending. The revised data shows that US consumers still maintain a growth momentum. In addition, the number of initial jobless claims in the United States has also stabilized at around 230,000, without a significant increase. Currently, all economic indicators are performing very solidly, and there are no clear signs that the economy is heading for a recession.

Data Source: Wells Fargo，Goldman Sachs

• Service sector indicators remain high, but manufacturing PMI has missed expectations for two consecutive months

The ISM non-manufacturing PMI rebounded sharply to 51.4 in July, still within the expansion zone; the non-manufactoring PMI for August also maintained this level, recording 51.5. However, the Manufacturing PMI has missed expectations for two consecutive quarters, with the US Manufacturing PMI index at 47.2 in August, below the expected 47.5. Although slightly higher than last month's 46.8, it is still operating in the contraction zone. Especially in August, the new orders component only recorded 44.6, down 2.8 points from last month, indicating that more and more companies are adopting a cautious and pessimistic attitude towards future market demand, which also lays hidden worries for the future economic trend.

Data Source: Bloomberg

2.2 Current market pricing and our view

• The market currently prices in five rate cuts this year, totaling 125 basis points, and ten rate cuts over the next year, totaling 250 basis points, which is already at the level of an economic crisis. As mentioned above, the US economy still has resilience, and core indicators such as the unemployment rate and consumption have only slackened rather than shrinkened. There is currently no sufficient evidence to support that the US is about to enter a recession. With inflationary pressures having significantly reduced, the Fed's initiation of a rate cuts cycle in September to reduce economic pressure is basically a done deal.

Data Source: CME Group, time:2024/9/11

• Based on the fact that US economic data does not show signs of recession in the short term, and combined with Powell's previous attitude, we believe that the Fed currently has enough time and space to initiate preventive rate cuts to ensure a successful soft landing of the economy, and we still maintain the view of three rate cuts this year. Therefore, we tend to participate in "rate cuts trading" rather than betting on "recession trading".

• In this scenario, equity risk assets may perform well, especially small-cap stocks, REITs, biotech sectors, and other interest rate sensitive assets. On the one hand, a soft landing means that economic growth remains stable. Although market demand has declined, it is still at a healthy level, which will provide fundamental support for the performance of small-cap stocks. On the other hand, the easing of interest rate conditions will significantly reduce the financing pressure on small companies, thereby promoting business expansion and valuation increases.

• In addition, a relatively stable economic growth rate will provide support for long-term interest rates, so there is relatively limited room for long-term bond prices to rise. Since short-term interest rates are highly correlated with the fed funds rate, the start of the Fed's rate cuts cycle is expected to open up downside space for short-term interest rates, and the performance of short-term bonds may outperform long-term bonds in the future.

• However, it still takes time for the market to digest the tense sentiment, and in the short term, the two types of trades are likely to swing back and forth. Coupled with the US election factor, macro risks have increased, and market volatility will also intensify. Therefore, act when the opportunity arises; buying low and selling high when the market pricing significantly deviates from reasonable levels is a good choice at present.

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