Why did the Federal Reserve cut interest rates by 50 basis points? What impact will it have on China? ,In-depth | Only 48 days left until the election

On September 18th local time, the Federal Reserve implemented its first interest rate cut in four years, lowering the target range of the federal funds rate by 50 basis points to between 4.75% and 5%, rather than a more conservative 25 basis points.

U.S. stocks rose in response to the excitement, but then fluctuated violently between gains and losses, ultimately closing with a slight decline.

American public opinion said that investors are still nervous. Is the Federal Reserve's 50 basis point interest rate cut a last-ditch move to prevent the US economy from falling into recession, or is it a cautious move to ensure that the US financial situation can remain sound for a longer period of time?

Since the Federal Reserve raised interest rates 11 times from near zero in March 2022, the U.S. federal funds rate has been hovering at the highest level in nearly 23 years, between 5.25% and 5.5%, for more than a year. The Federal Reserve has remained on hold at its monetary policy meetings for eight consecutive times.

Before this interest rate meeting, the outside world believed that the Fed's interest rate cut was a foregone conclusion, but the extent of the cut was still uncertain. Since the late 1980s, it has become normal for interest rate cuts to start with a 25 basis point cut for the first time, and a 50 basis point cut is an exception, which has only happened twice: once in January 2001 when the Internet bubble burst, and the other time during the subprime mortgage crisis in September 2007.

Now, why did the Federal Reserve go against its norm and choose such a "bold" start of cutting interest rates by 50 basis points at a time?

The explanation given by Federal Reserve Chairman Powell that day was still based on two indicators: inflation and employment.

On the one hand, the Fed is increasingly confident that the inflation rate will continue to approach 2%. After setting a historic record of 9.1% in June 2022, the US Consumer Price Index has been on a downward trend since June 2023, with the year-on-year increase last month falling to 2.5%, the smallest increase since February 2021.

On the other hand, the Fed hopes to maintain the "good situation" of the labor market. Since April 2023, the US unemployment rate has risen by 0.8 percentage points to 4.2% last month. Last month, the seasonally adjusted non-farm payrolls increased by 142,000, lower than the expected 160,000. The Fed believes that although the unemployment rate has risen, it is still low; US economic activity continues to expand at a steady pace.

American public opinion believes that there are various signs that the labor market is cooling down. The Federal Reserve seems to be sending a signal of "anxiety" with its "aggressive" interest rate cuts, and ensuring a "soft landing" for the economy seems to have become its current policy focus.

"Currently, the number of newly created jobs in the United States is lower than expected, and the unemployment rate is expected to rise to 4.4% this year. 50 basis points was the rate cut that the market had previously discussed, and it was ultimately supported by a majority of the Fed members. This shows that the Fed's concerns about the future prospects of the U.S. economy are beginning to rise. It wants to cut interest rates sharply to give the market a clearer expectation that the Fed's policy shift has begun," said Xu Mingqi, distinguished researcher at the Shanghai Institute of International Finance and Economics and vice chairman of the Shanghai International Economic Exchange Center.

Pan Rui, a professor at the Center for American Studies at Fudan University, pointed out that interest rate cuts actually reduce the costs of investment, consumption and social and economic operations. The Fed has reached the point where it needs to take action. At present, the signals released by the US job market are more risky: the unemployment rate is gradually rising, and many people have given up the idea of ​​job hunting. If it is delayed further, the US economy will continue to suffer the negative impact of high interest rates, and the Fed will face greater pressure and criticism. In addition, there are less than two months left before the US election. Although the Fed emphasizes that the decision to cut interest rates is based on economic data, political factors may still have a certain impact overall.

Judging from the latest dot plot of the Federal Reserve, the median forecast of the federal funds rate by the end of this year by policymakers has dropped from 5.1% to 4.38%, and the median forecast for the end of 2025 has dropped from 4.1% to 3.38%. "The interest rate cut channel has been opened, and doves still have the upper hand in the Fed's future policies." Pan Rui pointed out that if nothing unexpected happens, there should be two more interest rate cuts this year. Most members of the Federal Reserve believe that the total interest rate cut this year will be 100 basis points, and another 100 basis points will be cut by the end of 2025. However, the extent to which the interest rate cut channel will develop still depends on the overall performance of the US economy.

This is the first interest rate cut by the Federal Reserve in nearly four years, marking the beginning of a series of subsequent actions that will bring a series of subsequent impacts.

For borrowers, interest rate cuts will ease their repayment pressure and will affect interest rate decisions in countries whose currencies are pegged to the US dollar, thus benefiting borrowers in these countries.

The Fed’s interest rate cut will have complex impacts on different financial markets.

In the stock market, lower interest rates may push up stock prices: first, companies can borrow and invest with less money to improve corporate profitability; second, savings and other investments become less attractive, and investors may be more inclined to transfer funds to stocks. However, on the 19th, after the Federal Reserve’s interest rate decision was announced, the rise in U.S. stocks was short-lived, and then experienced a wave of shocks and ended in a decline.

"The Fed's rate cut was expected long ago. The reason why the U.S. stock market did not respond positively is mainly because the Fed also emphasized that it does not intend to stop shrinking its balance sheet in the near future, which will have an impact on liquidity expansion." Xu Mingqi pointed out that the rate cut will lead to a decrease in the cost of using funds, which is beneficial to consumption and investment in the United States. However, the stock market is still facing a situation where the supply of funds has not expanded particularly, so the stock market rise is not as obvious as expected.

In the foreign exchange market, interest rate cuts may reduce the attractiveness of US dollar assets. Since the Fed's current round of interest rate hikes, the US dollar has soared throughout 2022. However, after the Fed released a signal of a rate cut in September, the US dollar index fell significantly, and non-US currencies rose.

In terms of commodities, gold prices may rise accordingly, and other commodities such as oil, which are usually denominated in US dollars, will also be boosted by the stimulus brought by the interest rate cut.

However, some analysts believe that after the Fed starts the interest rate cut cycle, the performance of US stocks, bonds and the US dollar may depend mainly on another factor: the health of the US economy. Data since 1970 show that if the US economy does not fall into recession, the US stock index and the median of the US dollar against a basket of trade-weighted currencies will rise within 6 months to 1 year after the first interest rate cut.

Pan Rui pointed out that the interest rate cut means the "floodgates" are opened, and the overall liquidity of the US dollar is no longer completely affected. All kinds of global US dollar assets will not flow to the United States to push up US stocks as they did when the interest rate was raised, but will flow to all parts of the world. In theory, US stocks may fall, and the US dollar may have to pay a higher price to continue to maintain its strength against other currencies.

For many emerging economies, both analysts mentioned that the Fed's rate cut will have both positive and negative effects. The positive side is that "the liquidity of the US dollar will increase, and the pressure of capital outflow and currency depreciation will be reduced, which will to a certain extent open up space for countries to stimulate their economies through monetary policy." Xu Mingqi said.

The negative side is that "in many emerging markets, if some high-quality assets are priced very low, they will be bought up at the bottom. How emerging market countries respond will be the key," said Pan Rui.

"A decline in the U.S. dollar exchange rate will also have an adverse impact on many export-dependent countries, unless these countries can continue to maintain the weakness of their currencies relative to the U.S. dollar through monetary and domestic policies," Xu Mingqi pointed out.

From a global perspective, the Fed's interest rate cuts are not coming fast. The European Central Bank, the Bank of England, the Bank of Canada, the Swiss National Bank, the Swedish Central Bank and the central banks of some emerging economies have already cut interest rates.

What does the global “interest rate cut wave” mean? What impact will it have on China?

"The trends of other central banks around the world are worth paying attention to. Their monetary policy decisions are interrelated and highly correlated with the global economy and trade, and will also have an impact on my country's economic data and the central bank's financial and monetary policies." Pan Rui pointed out that, however, the independence of my country's central bank's monetary policy has always been very obvious. The US dollar has been raising interest rates, but my country's central bank has not followed the US dollar in raising interest rates. Instead, it has eased the liquidity of the RMB. After the Fed's interest rate cut this time, the external pressure on my country's economy will be slightly alleviated, and the RMB may appreciate, but industries such as foreign trade, overseas tourism, and studying abroad may also be affected. It is expected that my country's central bank will comprehensively consider the direction of monetary policy based on the changes and developments in the country's economic operation and financial situation, and will not blindly follow suit.

"At present, major developed countries around the world are facing slowing economic growth and are basically cutting interest rates to stimulate the economy. Against this background, the pressure on China's financial market will be reduced, and the space for monetary policy regulation will be expanded, which will be conducive to the further role of monetary policy." Xu Mingqi pointed out that at present, the mechanism and means of interest rate regulation in my country have changed, and are mainly operated through the open market. Next, the possibility of interest rate reduction will increase further. At the same time, my country still needs to rely on the further coordination of fiscal policy and monetary policy to stimulate the recovery of the entire economy and the growth of consumption.