It's not "recessionary rate cuts" but "preventive rate cuts"! CICC's Liu Gang: Don't misinterpret the impact of Powell's speech

Just when the market was still worried about whether Powell was still ambiguous, betting on both sides, emphasizing uncertainty, and following the traditional routine of watching and waiting, Powell came out with a clear "dovish" signal.

Moreover, the dovish signal was not presented in a subtle way through emphasizing the difficulties in the labor market as the market expected, but rather directly stated, "Due to monetary policy being in restrictive territory, the current baseline outlook and the shifting balance of risks may warrant adjusting our policy stance" (with policy in restrictive territory, the baseline outlook and the shifting balance of risks may warrant adjusting our policy stance), which can be considered a direct dovish stance.

Of course, Powell also backtracked a bit, saying that if the upcoming August non-farm payrolls or inflation exceed expectations, it would still be delayed. But in any case, it can be seen as directly supporting a rate cut in September.

The market's reaction was also strong, with U.S. Treasury yields and the dollar declining, and U.S. stocks soaring. The expectation for a rate cut in September jumped from 75% before the meeting to around 90%.

https://www.federalreserve.gov/newsevents/speech/powell20250822a.htm

Despite the previous July non-farm payrolls "avalanche" and the July CPI not exceeding expectations, the market still had doubts about a rate cut in September; otherwise, the probability of a rate cut wouldn't have dropped back to 75% recently.

We have always been more optimistic about the rate cut judgment than the market's view. This does not mean we are certain that there will definitely be a cut in September, but rather in the logic of judging the rate cut. The core difference lies in: 1) The Federal Reserve needs to cut rates, which is a major premise; high interest rates suppress traditional demand, such as real estate and manufacturing PMI, which continue to be weak; 2) The Federal Reserve is concerned about inflation getting out of control, rather than just a one-time impact. If the tariff path is determined and is moderate and controllable, then in the face of greater employment and growth challenges, there is no need to wait for inflation itself to fall before cutting rates.

The biggest misconception in the market is to emphasize only the impact of tariffs while ignoring the path. If we ask whether tariffs have any impact on inflation, the answer is unequivocally: yes, they have been gently rising over the past few months. However, the continuous inflation data from April to July over four months has repeatedly shown that inflation transmission is much slower than the market expected. The reasons behind this, in addition to the rush for imports and exemptions, include the fact that the actual scope of increased tariffs is very low (exempted goods and other products) and the issue of cost-sharing, which the market has overlooked Imagine if the Federal Reserve is faced with a more challenging pressure on growth and employment, while on the other hand, inflation transmission is much milder and more moderate than expected, and likely to be a one-time event. How would they choose? Even if there is a slow price transmission later, if it slows down enough to be offset by other factors, it becomes less urgent.

What about the impact of interest rate cuts? The market is likely to say without hesitation that it will boost risk appetite, lower U.S. Treasury yields and the dollar, just like today's reaction. But this is only half right, and it's another common misconception in the market.

• For U.S. stocks, it will indeed boost risk appetite, which is one of the reasons we further raised our U.S. stock targets. Why can the risk premium of U.S. stocks be so low? Our view on U.S. stocks is consistently more optimistic than market consensus, even during the one-sided "de-dollarization" and "triple kill of stocks, bonds, and currencies" at the end of April, looking back, it was indeed correct. But even now, we still raise our U.S. stock targets, conveying a clear message: raising targets does not mean there won't be corrections and volatility, but adjustments still provide better entry opportunities, not only because of the superficiality of interest rate cuts, but more due to improvements in the fundamentals. The improvement in fundamentals is due to the three main components of the credit cycle: 1) Continued strong investment in emerging industries represented by AI; 2) With the new fiscal year starting in October, the fiscal expenditure of the Inflation Reduction Act can also improve month-on-month; 3) After the Federal Reserve cuts interest rates, traditional demand such as real estate and manufacturing PMI employment gradually improves (yes, it's that fast, mirroring the immediate recovery after the Federal Reserve cut rates last year).

Recently, during the second quarter earnings season, U.S. stock earnings have been continuously revised upward, with the S&P 500 index's annual profit around 10%, matching this year's increase. If the above trend continues, next year's earnings may accelerate further (the current market expectation is 14%)

• However, the decline in U.S. Treasury yields and the dollar may not necessarily follow, which is a common "trap" in the market. Without going too far back, the start of interest rate cuts in September 2024 will coincide with the low points of U.S. Treasury yields and the dollar, with an upward trend throughout the entire rate-cutting cycle. The same was true in 2019. The reason is simple: this is not a recessionary rate cut but a preventive rate cut. When rate cuts can quickly boost demand, there is naturally no need for many cuts, and the market's trading focus will quickly shift from the denominator logic of easing brought by rate cuts to the numerator logic of fundamental improvement. Therefore, the expectation that this will have a boosting effect on emerging markets will also be dashed: during the 2024 Federal Reserve cycle, our market declined; during the 2019 rate-cutting cycle, our market fluctuated. Thus, indiscriminately deriving the impacts of rate cuts on interest rates, the dollar, and emerging markets without considering the context of the cuts is problematic.

For the Chinese market, it is not that rate cuts cannot translate into our benefits, but we cannot emphasize rate cuts themselves as the absolute dominant factor. Is the Federal Reserve's rate cut a positive or negative for us? If we can leverage the rate cut window to amplify domestic monetary and fiscal easing opportunities, it will naturally enhance the boosting effect on our market; conversely, relying solely on external rate cuts is ultimately not a core variable.

If we cannot expect total policy changes, we can also consider reflective logic, such as: 1) U.S. real estate chains that may benefit, such as furniture and home goods, and 2) investment chains that may benefit, such as non-ferrous copper, which can serve as structural directions, as seen in previous rate cut scenarios.

Key points from Powell's Jackson Hole speech:

Regarding the current economic situation and recent outlook:

1. The downside risks in the labor market are rising, and labor force growth has significantly slowed this year.

2. Tariffs have begun to push up prices for certain goods, and the impact of tariffs on CPI is now clear, with the basic assumption being a one-time effect. Long-term inflation expectations remain well anchored, and we will not allow inflation to become a persistent issue.

3. As monetary policy is in a tightening phase, we may need to adjust our policy stance.

Regarding the evolution of the monetary policy framework:

1. The wording indicating that the effective lower bound of interest rates is determined by economic conditions has been removed.

2. Returning to a flexible inflation targeting framework.

3. The phrase "we will commit to alleviating 'shortfalls' rather than 'deviations' from full employment" from the 2020 statement has had "shortfalls" removed. If the labor market or other factors pose risks to price stability, preemptive action may be necessary

4. Point out that full employment is "the highest level of employment that can be sustainably achieved under price stability," emphasizing that "sustained achievement of the highest employment enhances broad economic opportunities and benefits for all Americans."

5. Monetary policy must be forward-looking.

Author of this article: Kevin Liugang, Source: Kevin Strategy Research, Original Title: "The Dovish Pivot of Powell: Why Are We More Optimistic About Rate Cuts Than the Market?"

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