CICC Liu Gang: Is the Federal Reserve's interest rate cut really a good thing for the Chinese market?

With the expectation of a Federal Reserve interest rate cut rising in September (the current probability of a rate cut accounted for by CME interest rate futures is 92%), discussions in the market about the potential impacts of a Federal Reserve rate cut are gradually increasing. In addition to its effects on the U.S. economy and the U.S. stock market itself, one of the most concerned questions among investors is, what impact will a Federal Reserve rate cut have on the Chinese market? Is it a positive or negative effect?

On the surface, many investors may feel puzzled by this question, wondering what is worth discussing. Most investors might think that although a Federal Reserve rate cut may not be a decisive factor, it is likely to be beneficial for us in general, with the only difference being the degree of impact.

The most commonly cited impact pathway and transmission logic is: Federal Reserve rate cut → weakening of the U.S. dollar and U.S. Treasury yields + narrowing of the China-U.S. interest rate spread → inflow of overseas funds; if the domestic easing window can be further opened, the impact will be even more significant.

However, the reality may be quite the opposite, as there is a problem with the first step in the most commonly cited transmission pathway.

Federal Reserve Rate Cut = Weakening of U.S. Treasury Yields and U.S. Dollar? Not Necessarily

The biggest misconception in the market is directly applying the "historical experience" of previous rate cuts to arrive at a seemingly "unbreakable" conclusion: Federal Reserve rate cut = weakening of U.S. Treasury yields and U.S. dollar.

Even without considering more distant scenarios, if one were to trade with this mindset, the rate cut cycle last year would have been completely "mismanaged." In September 2024, when the Federal Reserve began to cut rates by 50 basis points, that moment marked the low point for both the 10-year U.S. Treasury yield and the U.S. dollar index, rather than the starting point for an unconventional downward expectation, and this upward trend persisted throughout the September-November rate cut cycle (Chart 2). This was also the core reason we repeatedly reminded that U.S. Treasury trading should be "counterintuitive" (see "New Ideas for Rate Cut Trading"). Looking further back, the same was true in 2019 (Chart 4) and 1995 (Chart 3).

Chart 1: The current probability of a September rate cut accounted for by CME interest rate futures is 92%

Source: CME, CICC Research Department

Chart 2: The beginning of the Federal Reserve rate cut in September 2024 marked the low point for the 10-year U.S. Treasury yield, which subsequently rose during the September-November rate cut period

Source: Bloomberg, CICC Research Department

Chart 3: After the Federal Reserve's "preemptive" rate cut in July 1995, the 10-year U.S. Treasury yield reached a short-term low

Source: Bloomberg, CICC Research Department

Chart 4: After the Federal Reserve's first interest rate cut in July 2019, the 10-year U.S. Treasury yield bottomed out.

Source: Bloomberg, CICC Research Department

Where is the problem? The key is to distinguish what kind of interest rate cut cycle it is ("How does the Federal Reserve cut interest rates?").

1) If it is a recessionary interest rate cut, then this conclusion is indeed valid, that is, the interest rate cut process will be accompanied by a continuous decline in U.S. Treasury yields and the U.S. dollar, and a sustained weakening of U.S. stocks. Coincidentally, historically, most interest rate cut cycles are of this nature, which gives everyone the illusion that interest rate cuts are accompanied by the aforementioned phenomena (Chart 13).

Chart 13: During a recessionary interest rate cut, U.S. Treasury yields decline and U.S. stocks continue to weaken.

Source: Bloomberg, CICC Research Department

Recessionary interest rate cuts are essentially overly lagging interest rate cuts, where the economy is already under significant pressure at the time of the cut, requiring substantial cuts to stabilize the economic downturn. Therefore, during the interest rate cut process, U.S. Treasury yields and the U.S. dollar index are affected by both monetary policy adjustments and economic slowdown, leading to a dual downward effect, until the stimulus effect of easing is sufficient to offset the downward effect of monetary policy adjustments. Thus, in this process, initially, short-term rates decline faster than long-term rates, and later, short-term rates decline while long-term rates rise, steepening the yield curve (Chart 14).

Chart 14: In the early stages of a recessionary interest rate cut, short-term rates decline faster than long-term rates; later, short-term rates decline while long-term rates rise, steepening the yield curve.

Source: Bloomberg, CICC Research Department

If we use real interest rates to represent costs and natural rates to represent returns, then a recessionary interest rate cut means that real interest rates are far above natural rates, requiring substantial cuts until real interest rates fall below natural rates for long-term Treasury yields and the U.S. dollar to stabilize (Chart 5).

Chart 5: A recessionary interest rate cut means that real interest rates are far above natural rates, requiring substantial cuts until real interest rates fall below natural rates.

Source: Bloomberg, Haver, CICC Research Department

2) If it is a preventive interest rate cut, this process will be significantly advanced and shortened. When interest rates are cut, the economic pressure is not as great, and the gap between the real interest rate and the natural interest rate is small, so a slight interest rate cut can boost demand, thus not requiring many rate cuts. The early incorporation of slight rate cut expectations and the rapid improvement in the economy after the rate cut will cause market trading to quickly shift from the rate cut logic to the economic improvement logic after the rate cut is realized, leading to a rebound in U.S. Treasury yields and the dollar. This was the case in September to November 2024, July 2019, and July 1995, all of which had relatively short rate cut cycles.

Chart 21: After the rate cuts in July 2019 and September 2024, long-term rates and the dollar rebounded, reflecting the investment uplift in copper.

Source: Bloomberg, CICC Research Department

Therefore, it is not difficult to see that indiscriminately borrowing historical experience without distinguishing the reasons for rate cuts and the macro background, and equating rate cuts with the decline of U.S. Treasury yields and the dollar, and then deducing further chain effects, may not only lead to market misjudgments but also result in "going in the opposite direction."

Currently, it is more similar to the latter, that is, a replica of 2024 and 2019. The U.S. economy is not without pressure, and traditional demand outside of technology has been continuously squeezed by high interest rates. For example, the ISM Manufacturing PMI has continuously declined from 50.9 in January 2025 to 48 in July, approaching the low point of 47 before the rate cut in 2024 (Chart 6); real estate demand remains weak, with existing home sales again nearing the low point of 3.9 million units in September 2024, and new home sales also continuing to slow year-on-year (Chart 7), all due to excessively high financing costs. From the perspective of the entire economy, the real interest rate (1.87%) is higher than the natural interest rate (1%) (Chart 8); from the perspective of real estate, the mortgage rate (6.82%) is higher than the rental yield (6.72%) (Chart 9); from the corporate perspective, the commercial loan rate (6.31%) is higher than the ROIC of the non-financial corporate sector (5.81%) (Chart 10).

Chart 6: The ISM Manufacturing PMI has continuously declined from 50.9 in January 2025 to 48 in July, approaching the low point of 47 before the rate cut in 2024.

Source: Wind, CICC Research Department

Chart 7: Existing home sales are again nearing the low point of 3.9 million units in September 2024, and new home sales continue to slow year-on-year

Source: Wind, CICC Research Department

Chart 8: The current real interest rate in the United States is approximately 0.9 percentage points higher than the natural interest rate.

Source: Haver, CICC Research Department

Chart 9: From the real estate perspective, as of June, the mortgage rate (6.82%) is still higher than the rental yield (6.72%).

Source: Haver, CICC Research Department

Chart 10: From the corporate perspective, the commercial loan interest rate (6.31%) is higher than the ROIC of the non-financial corporate sector (5.81%).

Source: Federal Reserve, FDIC, CICC Research Department

However, rather than "struggling" with whether the U.S. economy is under pressure, a more worthwhile question to explore is whether these pressures can be resolved quickly. The answer is affirmative; the Federal Reserve's interest rate cuts can address most of the traditional demand weakness. After the interest rate cuts in September to November 2024, the manufacturing PMI and U.S. existing home sales should rebound, and the reason it can happen so quickly is that costs and returns are "very close."

Therefore, the response of interest rates and the dollar to interest rate cuts may also be similar, which is why recent expectations for interest rate cuts have risen, but long-term Treasury yields have struggled to decline further. We expect that before the interest rate cuts are realized, there may still be slight downward space as the cuts are further confirmed, but after the cuts are realized, U.S. Treasury yields and the dollar may instead reach a temporary bottom, unless there are larger expectations for further cuts or other risk events replace them as the main pricing logic.

New Federal Reserve Chair = Larger Rate Cuts = Greater Rate Decline and Weaker Dollar?

So, will the new Federal Reserve Chair become the biggest risk to this judgment? It is certainly possible, but it amplifies the volatility without changing the essence of the logic.

After Powell's term ends in May 2026, the choice of the new Federal Reserve Chair and their decisions will indeed have an impact beyond the fundamentals. If they were to exceed expectations for rate cuts to align with Trump's demands, it would inevitably lead to a larger decline in U.S. Treasury yields and the dollar in the short term. We estimate that cutting rates 2 times to 3.75-4% corresponds to a 10-year U.S. Treasury yield center of 4-4.2%. By analogy, larger rate cuts will naturally lead to a further downward shift in the interest rate center. However, the underlying macro logic influenced by interest rates and the US dollar has not fundamentally changed, it is merely amplified by unexpected policy factors outside of these fundamentals, forming a larger fluctuation range than the 3.8-4.8% since 2023. This is because lower interest rates provide greater boosts to growth and inflation, while simultaneously constraining the downward space for interest rates, which in turn raises the interest rates, and higher interest rates suppress demand, which then leads to a decline in interest rates.

So, is the Federal Reserve's interest rate cut a positive or negative for the Chinese market?

Returning to the initial question, is the Federal Reserve's interest rate cut a positive or negative for the Chinese market?

From the analysis above, the answer is relatively clear. In the short term, it is positive, but this positivity may be shorter-lived and is not the most core driving factor in the outcome.

1) The short-term positivity is more reflected through liquidity and even sentiment, such as the short-term decline in US Treasury yields and the US dollar, which can directly affect the China-US interest rate spread, the liquidity of Hong Kong stocks, and alleviate the pressure on the Hong Kong dollar exchange rate and Hibor tightening (Chart 11, Chart 12) ("How does Hibor affect Hong Kong stocks?"). This sentiment can be linearly extrapolated and amplified, for example, the surge in expectations for interest rate cuts after last week's CPI data.

Chart 11: On August 1, the Monetary Authority again withdrew HKD 3.9 billion, withdrawing liquidity

Source: Wind, CICC Research Department

Chart 12: Hibor has slowly risen from its May low

Source: Wind, CICC Research Department

2) However, this short-term positivity may quickly reverse, because the interest rate cuts will not be significant, nor do they need to be more substantial. Moreover, after the interest rate cuts, the fundamentals may quickly improve, providing higher returns, which could lead to US Treasury yields and the US dollar potentially bottoming out and rising. Therefore, the logic that simply relies on interest rate cuts to provide a loose environment and attract overseas funds to "higher-return" emerging markets becomes invalid, as seen in September-November 2024 and July 2019. This is also the biggest misconception in the market when discussing the impact of the Federal Reserve's interest rate cuts.

Of course, there are two ways to amplify the benefits of the Federal Reserve's interest rate cuts to make them "work for us."

► One is to use the Federal Reserve's interest rate cuts as a window to implement more substantial monetary and fiscal easing, to support or even boost the credit expansion of new sectors (see the framework diagram for addressing current economic challenges (Chart 16) "Hong Kong Stock Market Outlook for the Second Half of 2025: Abundance of Funds and Scarcity of Assets"), which would have a far greater effect on the Chinese market than merely looking at the denominator effect brought by the Federal Reserve's interest rate cuts themselves. Last year's 924 was the most typical example, but unfortunately, the subsequent fiscal efforts could not be sustained, leading the market to continuously decline from its high in early October to the end of the year (Chart 17) .

Chart 15: The interest rate cut cycle is divided into recessionary cuts and preventive cuts.

Source: CICC Research Department

Chart 16: To address return expectations, rely on external intervention (fiscal counter-cyclical adjustment) or the emergence of new growth points (AI technology and new consumption).

Source: CICC Research Department

Chart 17: Last year’s 924 is the most typical example, unfortunately, the subsequent fiscal strength did not continue, leading the market to continuously decline from the high point in early October to the end of the year.

Source: Wind, CICC Research Department

Chart 18: For the Chinese market, interest rate cuts are not a decisive factor; domestic fundamentals have a greater impact.

Source: Wind, CICC Research Department

Chart 19: During the interest rate cuts by the Federal Reserve in 2019 and 2024, there was no significant inflow of foreign capital.

Source: Wind, CICC Research Department

► Secondly, structural Sino-U.S. mapping opportunities. The Federal Reserve's interest rate cuts will boost the currently weak demand in the U.S. real estate and traditional manufacturing sectors. Therefore, from the perspective of Sino-U.S. mapping, exports related to the real estate chain and certain commodities related to investment, such as non-ferrous metals, may be directly benefited. Similar situations occurred before the interest rate cut cycle in 2024 (Chart 20).

Chart 20: After the interest rate cut began in September 2024, exports related to the U.S. real estate chain and certain commodities related to investment, such as non-ferrous metals, became the benefiting direction.

Source: Wind, Bloomberg, CICC Research Department

Author of this article: Liu Gang, Source: CICC Insights, Original title: "CICC: Is the Federal Reserve's interest rate cut a boon or a bane for us?" Risk Warning and Disclaimer

The market carries risks, and investment should be approached with caution. This article does not constitute personal investment advice and does not take into account the specific investment objectives, financial situation, or needs of individual users. Users should consider whether any opinions, views, or conclusions in this article align with their specific circumstances. Investment based on this is at one's own risk