CICC: The resonance of liquidity between China and the United States may create a window for liquidity easing trades in the next 1-2 months

United States: The Federal Reserve Surprises with a Dovish Shift, Suggesting a Restart of Rate Cuts in September, Dollar Liquidity May Enter a Phase of Easing

At last Friday's global central bank annual meeting, Federal Reserve Chairman Jerome Powell surprised the market with a dovish stance, stating the need to adjust monetary policy to balance risks [1]. This statement suggests that the Federal Reserve may restart rate cuts at the September FOMC meeting, with the market pricing in an 86% probability of a rate cut in September (Chart 1).

Chart 1: Futures Market Expectations for September Federal Reserve Rate Cut Probability Rise to 86%

Source: Bloomberg, CICC Research Department

Powell's shift indicates that the Federal Reserve has chosen the latter in the dilemma between "controlling inflation" and "stabilizing growth," which can reduce the risk of a recession in the U.S. but increases the risk of stagflation. We expect that U.S. inflation has reached an upward turning point, and the upward cycle may last nearly a year (Chart 2).

Chart 2: Inflation Sub-Model Predicts U.S. Inflation May Continue to Rise Over the Next Year

Source: Haver, CICC Research Department

However, in the next 1-3 months, we believe investors will find it difficult to reach a conclusion on the duration and magnitude of the inflation rise. The Federal Reserve can also interpret the inflation rise as a "temporary" phenomenon. It may not be until the end of 2025 or early 2026 that sustained inflation increases challenge the "temporary inflation" narrative, hindering the pace and magnitude of the Federal Reserve's rate cuts. Therefore, the upcoming period may enter a phase of dollar easing. Historically, when the Federal Reserve cuts rates in the context of "rising inflation + declining growth," the dollar depreciates, gold rises, and U.S. Treasury yields decline, but U.S. stock performance is relatively mixed (Chart 3).

Chart 3: Historical Experience Shows that When the Federal Reserve Cuts Rates in the Context of "Rising Inflation + Declining Growth," the Dollar Depreciates, U.S. Treasury Yields Decline, Gold Rises, but U.S. Stocks Perform Relatively Mixed

Source: Bloomberg, Tonghuashun, CICC Research Department

Note: The rising inflation is based on the moving average of the core CPI year-on-year growth rate over the past 6 months, while the declining growth is based on the moving average of the GDP year-on-year growth rate over the past 6 months. The intersection of rising inflation, declining growth, and the Federal Reserve's rate cut range is used to calculate asset returns.

In this round of Federal Reserve easing cycle, the inflation outlook is the biggest variable, but the resistance to the dollar's downward cycle may be limited: if inflation pressure is lower than we expect, the fundamentals support the Federal Reserve's continued easing, pushing the dollar down. If U.S. inflation rebounds, and the Federal Reserve insists on rate cuts under political pressure, it may harm the Federal Reserve's independence and the dollar's credibility, also supporting the dollar's decline The decline of the US dollar reflects the easing of US dollar liquidity, which supports both domestic and foreign major asset classes, especially benefiting the performance of non-US stocks and gold (Chart 4).

Chart 4: During the decline of the US dollar, gold, commodities, and stocks tend to rise, with non-US stocks outperforming US stocks

Source: Haver, CICC Research Department

Investors were once concerned about the pressure of US Treasury issuance in Q3 this year. We believe it is worth paying attention to, but it may not be the main contradiction in the market, with limited impact on US dollar liquidity (《Major Asset Outlook 2025H2: Resilience and New Strategies》): Due to improved tariff revenues, the US fiscal deficit rate is declining, and the necessity to accelerate bond issuance is not high (Chart 5).

Chart 5: Due to improved tariff revenues, the US fiscal deficit rate is declining, and the necessity to accelerate bond issuance is not high

Source: Haver, CICC Research Department

The debt ceiling issue was resolved early in July, and the Treasury's funding needs were originally smaller than in previous debt ceiling periods. Moreover, the Treasury can gradually issue bonds to fill the funding gap, alleviating market pressure (Chart 6).

Chart 6: The debt ceiling issue was resolved as early as July, and the balance of the US TGA account is higher than in previous debt ceiling periods, reducing the amount needed for bond issuance to fill funding gaps

Source: Bloomberg, CICC Research Department

More importantly, liquidity in the US market remains ample, with bank reserves far exceeding levels during the "cash crunch" in 2019 (Chart 7), and the Federal Reserve can use liquidity tools such as SRF and SLR to timely supplement liquidity.

Chart 7: Ample liquidity in the US market, with bank reserves far exceeding levels during the "cash crunch" in 2019, reducing liquidity risk

Source: Haver, CICC Research Department

Therefore, we believe that the risks of US Treasury issuance are relatively controllable, and the main sources of overseas macro risks are economic fundamentals and Federal Reserve policies. Since the Federal Reserve has clearly stated its intention to downplay inflation risks and initiate a rate-cutting cycle, US dollar liquidity may improve in stages, boosting risk appetite.

China: Fiscal Policy Takes the Lead, Macro Liquidity Transforms into Stock Market Liquidity

After the "924" policy last year, the government increased leverage and fiscal efforts to inject money (Chart 8), with both M1 and M2 turning upward (Chart 9). Coupled with the low base effect from the cleanup of manual interest subsidies during the same period last year, the growth rate of M1 rebounded rapidly from a low of -3% to 5.6%. Macroeconomic liquidity continues to improve.

Chart 8: China's M2 has seen high growth in recent years, significantly contributed by fiscal efforts

Source: Wind, CICC Bank Group

Chart 9: M1 and M2 growth rates turn upward, M2-M1 spread narrows

Source: Wind, CICC Research Department

Since the "924" policy, the efforts have not only enhanced macro liquidity but, more importantly, effectively reversed pessimistic expectations, forming a policy put option that reduces the risk of stock market declines. During the Spring Festival, DeepSeek emerged, and innovative drugs, military industry, and other new sectors also welcomed their "DeepSeek moment," opening up upward space in the market. After the announcement of "reciprocal tariffs" in April, the resilience of Chinese stocks was evident, and the subsequent three rounds of Sino-U.S. trade negotiations lowered bilateral tariff levels, with some U.S. tariffs on China being postponed [2], greatly reducing external uncertainties. The combination of internal and external factors has significantly increased the expected returns on Chinese stocks (Chart 10).

Chart 10: Among residents' financial assets, stock market returns have significantly improved

Source: Wind, CICC Research Department

Residents' wealth needs to be allocated among the real estate market, stock market, bond market, and deposits. While the cost-effectiveness of stock allocation has risen, the low interest rate environment has weakened the attractiveness of bonds and deposits. The second half of the financial and credit cycle has diminished the appeal of real estate, leading to asset allocation demands that result in "deposit migration" into the stock market, meaning macro liquidity is transforming into stock market liquidity. In July, financial data showed that non-bank deposits increased by 2.1 trillion yuan, the second highest in history, and significantly higher than seasonal levels.

At the same time, the daily trading volume and turnover rate of A-shares have significantly increased (Chart 11), and the financing balance has entered a new round of expansion (Chart 12). The inflow of funds has driven the stock market up, and the rising stock market has attracted more funds, creating a positive feedback loop between stock market performance and capital flow, reinforcing the upward trend of the stock market.

Chart 11: A-share daily trading volume and turnover rate have significantly increased Source: Wind, CICC Research Department Chart 12: The financing balance of A-shares has entered a new round of expansion

Source: Wind, CICC Research Department

Logically, during periods of liquidity easing, funds can enter both the stock market and the bond market. However, in a low-inflation context, the correlation between Chinese stocks and bonds may remain negative for a long time, making it easier for a "stock-bond seesaw" to form rather than a "dual bull market" (Chart 13-Chart 14).

Chart 13: The correlation between Chinese stocks and bonds turned negative after the pandemic

Source: Wind, CICC Research Department

Chart 14: In a low-inflation period, growth expectations dominate market trends, leading to a decrease in stock-bond correlation turning negative

Source: Wind, CICC Research Department

Synchronized liquidity between China and the U.S. creates a market window period, with risks in sustainability and volatility

As liquidity in both the U.S. and China is marginally tending towards easing (Chart 15), and with time remaining until the next round of U.S.-China negotiations in November, the next 1-2 months may serve as a window period for liquidity easing trades, providing a relatively favorable macro environment for major asset classes such as Chinese and foreign stocks, gold, and U.S. Treasuries.

Chart 15: Both China and the U.S. M2 are on the rise, indicating potential synchronized liquidity easing

Source: Wind, CICC Research Department

However, it is important to be cautious, as synchronized easing of internal and external liquidity may also be temporary, and the sustainability of the market remains uncertain: externally, if U.S. inflation continues to rise, it may ultimately disrupt the Federal Reserve's interest rate cuts and the pace of U.S. dollar liquidity easing. Internally, with this year's fiscal policy being proactive and the pace of government bond issuance being relatively fast (Chart 16), if there are no further stimulus policies, the pace of government bond issuance may begin to slow down, leading M2 and social financing to reach a downward turning point, tightening macro liquidity.

Chart 16: This year's fiscal policy has been proactive, with a fast pace of government bond issuance

Source: Wind, CICC Research Department In addition, in a liquidity-driven market, risk assets such as stocks have already experienced a significant rise. As we approach the important celebrations at the beginning of September, with domestic and foreign economic data being disclosed in early September, asset volatility may increase. The current market environment presents both risks and opportunities.

Asset Allocation Recommendations: Overweight A-shares, Hong Kong stocks, and gold; standard allocation for US and Chinese bonds; underweight commodities; adjust US stocks from underweight to standard allocation

The resonance improvement in the liquidity environment between China and the US is likely to lead to a further decline in the US dollar, benefiting various assets (stocks, bonds, gold, commodities). It is recommended to increase risk appetite and overweight Chinese stocks.

From a valuation perspective, the dynamic price-to-earnings ratio of the CSI 300 Index is 14 times, close to the historical average (15.5 times). During the bull market cycles of 2021, 2015, and 2009, the price-to-earnings ratio of the CSI 300 reached 31 times, 37 times, and 42 times, respectively. The valuation of Chinese stocks still has room for upward movement (Chart 17).

Chart 17: The price-to-earnings ratio of the CSI 300 is below the historical bull market peaks

Source: Wind, CICC Research Department

From the perspective of potential off-market funds, the positioning level of private equity funds is below the historical average, and the A-share positioning of actively managed equity mutual funds has dropped to a ten-year low. Active foreign capital is still underweight in Chinese stocks. Overall, the profit effect and capital inflow may continue to form a positive cycle with stock performance. However, due to the previous significant rise and the need for improvement in the economic fundamentals, short-term volatility in the market may increase in early September.

Regarding US stocks, we previously suggested that a clear policy shift forms a market turning point (Chart 18).

Chart 18: Historically, shifts in US monetary policy and the easing of global political conflicts have usually been catalysts for stock market rebounds

Source: Bloomberg, CICC Research Department

Since Trump has significantly corrected economic policies and the Federal Reserve has clearly shifted to easing, we recommend adjusting US stocks from underweight to standard allocation. However, not being pessimistic does not mean turning optimistic: from a valuation perspective, US stocks are still relatively expensive compared to US bonds and non-US stock markets, with the equity risk premium of the S&P 500 Index close to 0% (Chart 19). At the same time, the volatility of US stocks is too low, which does not match the interest rate environment and may pose potential risks (Chart 20).

Chart 19: US stocks are still relatively expensive compared to US bonds and non-US stock markets

Source: Bloomberg, CICC Research Department Chart 20: The relative term spread of the VIX in the US stock market is severely underestimated

Source: Bloomberg, CICC Research Department

Based on past market performance when the Federal Reserve cut interest rates during stagflation, US stocks may not necessarily rise. During historical periods of US dollar depreciation, US stocks often underperform non-US markets after accounting for losses in the dollar exchange rate, indicating that US stocks are not the dominant direction among global equity assets. From the beginning of 2025 to now, the Shanghai Composite Index has accumulated a return of 16%, higher than the S&P's increase of 10%, and the Hang Seng Index's return of 30%, significantly surpassing the Nasdaq's increase of 11%. Considering the 2% depreciation of the dollar against the yuan, Chinese stocks have clearly outperformed US stocks, consistent with historical patterns during periods of dollar decline. In terms of risk and return, we believe that the cost-performance ratio of A-shares and Hong Kong stocks relative to US stocks is higher.

With liquidity shifting to a loose stance, the decline in real interest rates and the US dollar index is also favorable for gold performance, and we maintain an overweight position in gold. Gold prices rose rapidly at the beginning of the year, exceeding levels consistent with fundamentals, leading to increased short-term volatility. From a long-term trend perspective, the current rise in gold prices is both lower in magnitude and duration compared to previous gold price upcycles, suggesting that we may still be in the early stages of a bull market (Chart 21).

Chart 21: Compared to the magnitude and duration of historical gold bull markets, the current gold market may still be underperforming, and we may still be in the early stages of a gold bull market

Source: Wind, CICC Research Department

We recommend downplaying the trading value of gold and focusing on long-term allocation value, increasing allocation on dips. Chinese interest rates have declined too quickly relative to economic fundamentals over the past two years (Chart 22), and the increase in risk appetite has suppressed bond market performance due to the "stock-bond seesaw" effect, suggesting that interest rates may converge towards economic fundamentals.

Chart 22: Over the past two years, the decline in bond rates has been too rapid relative to economic fundamentals, and under the "stock-bond seesaw" effect, bond rates may temporarily converge towards economic fundamentals

Source: Haver, Budget Lab, CICC Research Department

However, against the backdrop of a declining credit cycle and economic growth center, the long-term trend of declining interest rate levels remains a prevailing trend (Chart 23).

Chart 23: According to international experience, in the second half of the credit cycle, the private sector deleverages, and interest rates are often in a long-term downward cycle

Considering various long and short factors, we recommend a standard allocation to Chinese bonds. Although the supply risk of U.S. Treasuries this year is manageable, inflation risks may gradually rise in 1-2 quarters, increasing market uncertainty. If secondary inflation is delayed or the U.S. economy significantly declines, there is a possibility that the yield on 10-year U.S. Treasuries could drop below 4%; however, on the other hand, a rebound in inflation could very well lead the Federal Reserve to slow down the pace of interest rate cuts after a reduction in September, causing rates to rise again. We maintain a neutral stance on U.S. Treasuries and recommend maintaining a standard allocation.

Authors of this article: Li Zhao, Yang Xiaoqing, Source: CICC Insights, Original Title: "CICC: The Window Period of U.S.-China Liquidity Resonance"

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