China International Capital Corporation (CICC) pointed out that the US CPI further weakened in June, coupled with Powell's dovish remarks, opening the "door" for the Federal Reserve to cut interest rates. The market's expectation for a rate cut in September has also risen to 90%, making it a "probable event". It is expected that US inflation will continue to fall in the third quarter, so if nothing unexpected happens during this period, the rush to the election is also a critical window for interest rate cuts. After half a year of brewing and "pendulum like" fluctuations, it seems that interest rate cuts are finally about to become a reality.
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CICC: Interest Rate Reduction Trading Manual
Zhongjin Research
The further weakening of CPI in June, coupled with Powell's dovish remarks, opened the door for the Federal Reserve to cut interest rates. The market's expectation for a rate cut in September has also risen to 90%, making it a "probable event". We estimate that inflation in the United States will continue to fall in the third quarter, so if nothing unexpected happens during this period, the rush to the election is also a critical window for interest rate cuts. After half a year of brewing and "pendulum like" fluctuations, it seems that interest rate cuts are finally about to become a reality.
So, have assets been traded as expected or based on historical experience? For example, many people may cite historical experience to worry that the market often falls during the interest rate cut cycle, which is actually a direct copy without distinguishing the underlying reasons. Also, is the start or end of the interest rate cut trading? Which asset will benefit more and how will the Chinese market perform? It seems that there is no such thing as a linear one. The hawkish interest rate cut by the European Central Bank in June gave a different revelation. We will provide answers to the above questions in this article.

Monetary policy path: inflation cooling strengthens the probability of interest rate cuts in September, and the third quarter is a critical window period
The rise in US Treasury rates in the second quarter has tightened financial conditions, causing the economic data released since July to weaken, further pushing up expectations of interest rate cuts, becoming a "mirror" of the fourth quarter of last year and the first quarter of this year. This is also what we have been reminding us that the less we expect interest rate cuts, the more we can lower them, and the more we expect interest rate cuts, the more we cannot. The reason for this is due to the particularity of this cycle. Due to the close financing costs and investment returns of various departments, it is not necessary to cut interest rates much in order to restart the credit cycle and boost demand. This is also why the market's early "rush" may delay the urgency of the Federal Reserve's interest rate cut. The implied expectation of interest rate cuts in the current CME interest rate futures shows that the probability of a rate cut in September has risen to 90%. If there are no unexpected events (such as sudden supply shocks or excessive interest rate cuts in the market leading to further easing of financial conditions and improved demand), we believe that a rate cut will also become a probable event. Therefore, interest rate cuts may gradually begin.
The third quarter is a critical window period for the Federal Reserve to cut interest rates, but cutting interest rates does not mean that it can be reduced significantly, and the opening of interest rate cuts does not mean that the interest rate cut trade can last for a long time. On the one hand, we estimate that the third quarter will be a period of rapid inflation decline, providing a window for interest rate cuts. In the fourth quarter, inflation will slightly rebound and the election will enter a sprint period. On the other hand, the purpose of this interest rate cut is not economic recession, but to alleviate the constraints of monetary policy and the problem of yield curve inversion, so there is no need for continuous and significant interest rate cuts.
The "general" pattern of previous interest rate cut cycles: simple "historical averages" are meaningless, and the current situation is more similar to 1995 and 2019
From a general perspective, we first summarized the frequency and average annualized performance of various assets achieving positive returns in the first, third, and sixth months before and after the start of the six interest rate cut cycles since the 1990s using a simple average method. Overall, the performance of US Treasury bonds, gold, and the Shanghai Composite Index was stronger before the interest rate cut, while industrial metals, crude oil, Hang Seng Index, Nasdaq, and US dollar performed better after the interest rate cut; The elasticity of Hong Kong stocks is greater than that of A-shares; At the industry level, defensive and growth sectors led the gains before the interest rate cut, and remained the same after the cut. However, the performance of pro cyclical sectors improved in the 3-6 months after the cut.
However, the biggest problem with simply averaging historical experience is that it masks the differences between each time. Interest rate cuts are the result rather than the cause, so when judging the impact on assets, we should start from the economic environment rather than simply copying the historical experience of interest rate cuts. Most interest rate cuts in history have been in recession scenarios, while this round is a precautionary cut, so there is a fundamental difference in the impact on assets.
Therefore, a more meaningful way is to find comparable stages, and the current environment of interest rate cuts is more informative compared to 1995 and 2019. Before the interest rate cuts in 1995 and 2019, the economy slowed down but did not decline, and achieved a soft landing after a small interest rate cut. In terms of assets, gold and US bonds performed better before the interest rate cut, but their gains narrowed after the cut, gradually shifting from the denominator to the numerator driven logic of US stocks and copper. Domestic assets rebounded slightly in the early stages of interest rate cuts, but the magnitude was limited and relied more on their own fundamentals. For example, in 2019, even though the Federal Reserve cut interest rates and the domestic fundamentals were repaired in an L-shaped pattern, the market showed more structural market fluctuations within a range.
The "unusual" pattern of this cycle: the interest rate cut cycle is relatively short, the easing has passed half, and the denominator benefiting assets are gradually switching to numerator benefiting assets
The current round of interest rate cuts is more similar to 2019, and we have summarized the following three characteristics: 1) The extent of interest rate cuts is limited during an economic soft landing. Due to the favorable economic fundamentals, the decline in interest rates after interest rate cuts has led to a loosening of overall financial conditions, which may activate private sector investment and consumption demand. Therefore, there is no need for consecutive significant interest rate cuts. We estimate that easing the restrictions of monetary policy and the problem of yield curve inversion in this round only requires a 100bp interest rate cut. This also means that the expectation of the domestic central bank opening up the space for significant interest rate cuts after the easing of external pressure still needs to be observed. 2) The interest rate cut transaction has already taken off. The current market's expectation for the number of interest rate cuts is still higher than the guidance provided by the Federal Reserve's dot matrix, as well as the magnitude required for monetary policy to return to neutrality that we have calculated. We calculate that gold is included the most, while US bonds are included less. 3) High trading concentration and accelerated rotation. Reviewing several rounds of trading since the beginning of this year, such as the sharp rise of Bitcoin and Nasdaq at the beginning of the year, followed by the Japanese stock, gold, copper, and Hong Kong stock markets once again switching back to the leading technology companies in the US stock market. The result of capital clustering is that some transactions are more concentrated, so it is easy to experience a short-term decline caused by "rotation", such as the "big cut small" of leading technology stocks to small cap stocks after the release of CPI, and the style shift of China's market from gold and non-ferrous metals to banking and real estate.
Therefore, considering the short cycle of this round of interest rate cuts, market competition, and concentrated trading characteristics mentioned earlier, we suggest that for this round of interest rate cuts, it is necessary to take a moderate half step in advance. 1) In the initial stage, assets that benefit solely or more from denominator logic have greater elasticity (typical such as US bonds, gold, small cap growth, and some growth stocks in the Hong Kong stock market), but may gradually end after the interest rate cuts are realized, especially without fundamental support, which cannot last far. 2) In the later stage, we should gradually shift to interest rate cuts to improve sub fundamental assets (typical such as US stock post cycle, leading technology stocks, copper, or sectors that benefit from domestic interest rate cuts). Specifically,
Overseas assets: Switching from loose trading to re inflation trading, although the denominator has a large elasticity in the initial stage, it gradually shifts to numerator benefiting assets after interest rate cuts are realized. In terms of rhythm, the initial main trend is loose trading, but it is necessary to "stop in moderation" and "fight and retreat", and switch to re inflation trading after the interest rate cut is realized. Benefiting from loose interest rate cuts, transactions such as US Treasury bonds and gold can still be participated in, but due to asset rush, the easing has already passed half. When the interest rate cut is realized, it may also be the end of the interest rate cut transaction, gradually shifting towards assets that benefit from re inflation, such as bulk resources such as copper and oil, and the cyclical sectors of the US stock market.
In terms of assets, focus on assets that benefit both the numerator and denominator from interest rate cuts, and be cautious about assets that benefit only the denominator. In general, after a rate cut, it will follow the order of leading technology (numerator profitable) → small cap growth (denominator liquidity) → cyclical finance (numerator repaired after a rate cut). However, considering the situation of "rushing" and "rotation", as well as the limited number of interest rate cuts in this round, assets that only benefit from the improvement of liquidity at the denominator end of the interest rate cut but have no other benefit logic need to "fight and retreat", such as US bonds, gold, and small cap stocks lacking profit support. On the contrary, assets that address both numerator and denominator issues through interest rate cuts would be better. After the interest rate cut, benefiting from the increase in demand brought about by the decline in financing costs, the relative allocation value of assets with improved profitability at the molecular end has increased. For example, top tech stocks compared to small cap stocks lacking profit support, cyclical sectors such as finance and real estate, and copper compared to gold.
Chinese assets: Initial growth stocks may benefit, but with limited external environment space, it is still recommended to focus on structural opportunities in the future. On the one hand, the Fed's interest rate cuts will still provide some support in terms of liquidity. We estimate that if the 10-year US Treasury bond falls to 3.8-4% (corresponding to 4-5 interest rate cuts in the next year), risk appetite and profits remain unchanged, and the Hang Seng Index is expected to approach 18500-19000 points. If risk appetite further recovers to the level of early 2023, the market is expected to further reach around 20500-21000 points, and the logic of the Shanghai Composite Index is similar. On the other hand, fundamentals remain the main influencing factor for the performance of the domestic market. In the fourth quarter of last year, the 10-year US Treasury bond interest rate fell by about 0.7 ppt from 4.6% to 3.9%, and the domestic market continued to decline. Looking ahead, we believe that whether the upward space in the market can be opened still depends on the domestic fundamental repair situation and policy catalysts. On the positive side, the Federal Reserve's interest rate cut is expected to open up domestic interest rate cutting space, which will help alleviate the still high financing costs.
In terms of sector allocation, short-term interest rate cuts can focus on liquidity benefiting assets. Historical experience shows that Hong Kong stocks are better than A-shares, and growth sectors such as semiconductors, automobiles (including new energy), media and entertainment, software, and biotechnology may have higher elasticity. On the contrary, high dividend payouts may lead to stage losses, but it is also a normal phenomenon. However, short-term liquidity drivers do not change the overall allocation pattern. We believe that unless the government makes significant efforts to hedge against the contraction of private credit, there will still be a structural market under a volatile pattern, with a focus on three directions: overall return decline (stable returns with high dividends and high buybacks, i.e. cash cows with ample cash flow), local leverage (policy support and still thriving technological growth), and local price increases (natural monopoly sectors, upstream and public utilities).
Risk Warning: Federal Reserve's interest rate cut path exceeds expectations, financial risks or sudden economic recession pressure, supply side inflation pressure exceeds expectations