To The Moon

Hi Tigers!

Recently, expectations of a Federal Reserve rate cut have been intensifying. The "Super Macro Week" combined with the "Super Earnings Week" has triggered a series of black swan events, leading to severe turbulence in global capital markets. As investors, how should we position ourselves?

In July, U.S. employment data showed widespread weakness, with nonfarm payrolls increasing by only two-thirds of the expected amount, and the unemployment rate climbing further to 4.3%. The U.S. earnings season has seen frequent disappointments, with Intel’s revenue, earnings, and guidance all collapsing, resulting in a 30% drop in its stock price. Meanwhile, geopolitical tensions in the Middle East have escalated once again. Instantly, a confluence of unfavorable factors has heightened fears of a recession, causing panic to sweep through the markets. Will the Fed cut rates soon?

Source: Bloomberg, time: 2024/08/08

Source: Bloomberg, time: 2024/08/08

As investors, how should we position ourselves? Let’s first take a look at the three typical views on the U.S. Treasury yield path from top institutions:

1、Goldman Sachs: The market is overpricing the recession; bond prices are under pressure for correction.

Recently, U.S. economic data has been weak, and the Federal Reserve has stated that they would quickly cut rates if needed to support the economy. As a result, U.S. Treasury yields have fallen sharply and shown a clear steepening trend. However, Goldman Sachs believes that the market’s reaction to short-term rate cut risks is somewhat excessive and not entirely aligned with the Fed’s actual policy path. They argue that there won’t be major issues in the U.S. economy in the short term, and there isn’t enough evidence to suggest a sharp deterioration in the labor market or financial market functions. Although the weakening economy has increased market expectations for a Fed rate cut, the rationale for such expectations is limited. Based on the current data, it is difficult to justify an emergency rate cut between meetings or A rate cut more than 50bps. Additionally, Goldman Sachs points out that the changes in market expectations are mainly due to adjustments in short-term rate expectations rather than a compression of term premiums. Even considering recession risks and rising expectations for Fed rate cuts, the 10-year Treasury yield remains centered above 4%, about 30 basis points higher than current market pricing.

Summary: Goldman Sachs believes that the market is overly optimistic about a significant Fed rate cut in the short term. Despite weak economic data, the Fed may not cut rates as quickly or significantly as the market expects. The 10-year Treasury yield is likely to remain above 4%.

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2、JPMorgan Chase & Co: The U.S. economy is weakening significantly, and Treasury yields will continue to decline.

Recently, U.S. economic data has continued to deteriorate. The July employment report showed nonfarm payrolls increasing by only 114,000, below expectations. Additionally, last month’s data was revised downward. The unemployment rate rose by 0.2 percentage points to 4.3%, marking the fourth consecutive monthly increase, with the overall unemployment rate now 0.9 percentage points higher than its cyclical low. These data have further heightened concerns about the vulnerability of the labor market, drawing increasing attention from policymakers. JPMorgan’s economists have revised their expectations for the federal funds rate after analyzing the latest employment report. They now predict that the Fed will cut rates by 50 basis points (0.5%) in both September and November, and continue to cut rates by 25 basis points at each Federal Open Market Committee (FOMC) meeting until rates reach 3% next year. This forecast aligns with the widespread market expectation that the Fed will adopt a more aggressive easing policy. JPMorgan expects that by the end of 2024, the 2-year and 10-year Treasury yields will reach 3.20% and 3.50%, respectively, while the Secured Overnight Financing Rate (SOFR) and the Effective Federal Funds Rate (EFFR) are expected to reach 4.10%.

Summary: Due to deteriorating economic data and a weakening labor market, JPMorgan expects the Fed to significantly cut rates in the coming months, ultimately lowering rates to 3%. Their forecast aligns with the market’s expectation of more aggressive Fed rate cuts.

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3、Morgan Stanley: A weakening U.S. economy reinforces rate cut expectations; defensive sectors will have opportunities.

Morgan Stanley (MS) believes that although the market generally expects the Fed to cut rates, historical experience shows that during periods of Fed rate cuts, the best-performing stocks are usually not cyclical stocks and small-cap stocks, but rather defensive stocks and large-cap stocks. This is because small-cap stocks and stocks closely tied to the economic cycle are more sensitive to economic conditions, and these stocks typically rely on price increases to achieve profits. When the Fed cuts rates, it often indicates a weakening ability to raise prices, which is unfavorable for these stocks. MS’s chief strategist, Wilson, also points out that although the market may believe that rate cuts will benefit cyclical and small-cap stocks, last Friday’s market performance proved the historical experience: despite a 27 basis point drop in the 2-year Treasury yield, small-cap and cyclical stocks still underperformed. Therefore, Wilson and his team recommend that investors should favor large-cap stocks in the current market environment. They also believe that the recent sharp decline in small-cap stocks further supports this view. As the market waits for the next Fed meeting, investors may pressure the Fed by lowering yields and price-to-earnings ratios, or even widening credit spreads. Since the Fed is not inclined to overreact, there is unlikely to be a significant change in policy guidance or a sudden rate cut between meetings.

Summary: MS advises investors to focus more on large-cap and defensive stocks under the expectation of Fed rate cuts, as these stocks tend to perform better during economic downturns, while small-cap and cyclical stocks may face adverse impacts.

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🐯🐯🐯Which viewpoint do you pick?

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Disclaimer: Not financial advice. Investment involves risk. This advertisement has not been reviewed by the Monetary Authority of Singapore.