Original author: Deep Tide TechFlow.
Introduction.
In today's ever-changing global economic landscape, the direction of the Federal Reserve's monetary policy impacts global financial markets. In September 2024, the Federal Reserve cut interest rates for the first time since 2020, initiating a new round of rate cuts.
Binance Research recently released a report that thoroughly elaborates on the background of the Federal Reserve's interest rate policy and its impacts on the economy and various asset classes.
The report starts from basic economic theory, combining the latest data and historical experience, to systematically analyze the relationships between core economic indicators such as interest rates, inflation, and employment. It also provides a comprehensive analysis of the performance of different asset classes such as stocks, bonds, commodities, and cryptocurrencies during rate cut cycles, offering clear decision-making references for investors.
Deep Tide TechFlow has summarized the key information of this report, as follows.
Key points.
Latest rate cut dynamics: The Federal Reserve announced a 0.5% rate cut in September 2024, followed by a further 0.25% cut in November, marking the first rate cut action since the COVID-19 pandemic measures in March 2020. The market expects further rate cuts of 1-2 percentage points in 2025, with a probability of approximately 62% for another 0.25% cut in December.
Policy background analysis: The Federal Reserve adheres to a dual mandate, committed to promoting maximum employment and maintaining price stability (inflation target of 2%). In mid-2022, inflation once broke through 9%, prompting the Federal Reserve to take aggressive rate hike measures, raising rates to the highest level in 20 years. As inflation gradually cools, the Federal Reserve initiates a new round of rate cuts.
Interest rate influence mechanism: As the price of money, changes in interest rates will affect the market through two main channels:
Lower borrowing costs, making it easier for market participants to access funds while reducing existing debt burdens.
Lower risk-free yields, pushing investors to seek other investment channels to increase returns.
Historical trends: U.S. interest rates have shown a structural downward trend over the past 50 years, decreasing from 8-10% in the 1980s to near-zero rates in the 2010s, and recently above 5%.
Asset performance analysis:
The stock market (S&P 500) generally shows an upward trend after interest rate cuts, but exceptions may occur during economic recessions.
The relationship between commodities and interest rates is complex, influenced by multiple factors including inventory costs, lack of yield, and exchange rates.
Bond prices exhibit a clear inverse relationship with interest rates.
Although historical data on cryptocurrencies is limited, they have shown strong performance during rate cut cycles, such as a 537% increase within 12 months after the rate cut in March 2020.
Policy shift: The global central bank rate cut curtain has been raised.
On September 18, 2024, the Federal Reserve lowered the target range for the federal funds rate by 0.5 percentage points to 4.75-5.00%, marking the first rate cut since March 2020 in response to the COVID-19 pandemic. Prior to this, in response to rising inflation, the Federal Reserve had aggressively raised rates from March 2022 to July 2023, and then maintained rates unchanged for eight consecutive meetings until this rate cut. The 0.25% cut in November further confirmed the beginning of a new round of rate cuts.
The Federal Reserve's policy actions have always revolved around its dual mandate: to promote maximum employment and maintain price stability. In the post-pandemic era, prices rose rapidly, with inflation breaking through 9% in mid-2022, prompting the Federal Reserve to initiate the strongest rate hike cycle in 20 years, raising the target rate from 0-0.25% during the pandemic to 5.25-5.50%. As inflation gradually cools, the Federal Reserve begins to shift towards easing. The current market expects a rate cut space of 1-1.5 percentage points in 2025, with a probability of about 62% for a 0.25% cut in December (and a probability of about 38% for maintaining unchanged).
The relationship between inflation, rate cuts, and the broader economic system (including asset performance) is intricate and worthy of deep attention from market participants.
It is worth noting that in 2024 many central banks around the world have begun the process of rate cuts, and this trend will have far-reaching impacts on global financial markets.
Basic concepts: The relationship between interest rates and the economic operation mechanism.
Warren Buffett once said: Interest rates drive everything in the economic universe. Let us start from the most basic concepts to understand how interest rates influence economic operations.
The basic principles of interest rates.
• Core definition: Interest rates are essentially the price of money.
Higher interest rates = money more expensive.
Lower interest rates = money cheaper.
The two major impacts of the current rate cut environment
1. Debt and lending effect
Businesses and institutions can obtain financing at lower costs, promoting investment expansion.
The interest burden on existing debt decreases, improving cash flow.
Consumer borrowing costs decline, stimulating consumption and housing demand.
Overall economic activity is boosted, contributing to economic growth.
2. Yield effect
Yields on risk-free assets such as government bonds decline.
Investors are forced to seek other investment channels for higher returns.
Valuations of risk assets such as stocks and real estate are supported.
Funds shift from low-risk assets to high-risk assets.
Major economic variables
Inflation
The Federal Reserve has set a long-term target inflation rate of 2%.
In mid-2022, inflation once broke through the high of 9%
Employment situation.
The current unemployment rate remains at a relatively healthy level of 4.1%
Non-farm payroll data is released on the first Friday of each month and is an important market indicator.
Market environment and external factors.
Corporate earnings: quarterly reports and expectations serve as a barometer of market confidence.
Regulatory policies: The regulatory stance on financial innovation, including cryptocurrencies (as shown in the chart below, where the number of crypto-friendly individuals in the U.S. House and Senate has significantly increased in elections).
Geopolitics: External shocks such as international trade relations and regional conflicts.
Macroeconomic indicators: including trade balance, consumer confidence, PMI, etc.
Historical perspective: Past Federal Reserve rate cut cycles and asset performance.
Interest rate change trends
Over the past 50 years, U.S. interest rates have shown a structural downward trend:
1980s: Maintained at a high level of 8-10%.
2010s: Approaching near-zero interest rates.
Recently: Rising above 5%.
September and November 2024: A new round of rate cuts begins.
Historical performance of various asset classes
Stock market (S&P 500)
Overall trend: Generally rises after rate cuts.
Specific performance:
First rate cut in September 1984: 3 months + 1%, 6 months + 9%, 12 months + 14%.
Rate cut in July 1995: 3 months + 6%, 6 months + 13%, 12 months + 22%.
Special cases: Negative yields occurred in 2001 and 2007 (during economic recessions).
January 2001: 12 months -12%
September 2007: 12 months -18%
Commodities
Influencing factors:
Inventory costs: interest rates affect holding costs
Yield characteristics: no fixed income
U.S. dollar exchange rate: most commodities are priced in dollars
Inflation correlation:
Often seen as a leading indicator of inflation.
Commonly used as an inflation hedging tool.
Bonds
Core characteristic: Clearly inverse relationship with interest rates.
Operating mechanism:
Interest rate rises → bond prices fall
Interest rate falls → bond prices rise
10-year Treasury yield: highly correlated with the federal funds rate.
Cryptocurrency
Historical data: has only experienced two rate cut cycles (the second half of 2019 and March 2020).
Performance highlights:
Rate cut in July 2019: 12 months + 25%
Rate cut in March 2020: 12 months + 537%
Special considerations:
Short sample period.
The market size is relatively small, with high volatility.
Influenced by multiple factors, not limited to interest rate changes.
This historical review shows that while rate cuts usually support asset prices, the specific performance varies by asset class and macro environment. Especially during economic recessions, even rate cuts may not prevent asset prices from falling, which suggests that investors need to consider multiple factors comprehensively, rather than simply making investment decisions based on whether rates are cut.
Conclusion: The global rate cut cycle has begun, presenting both opportunities and challenges in the market.
As the report shows, September 2024 became the fourth largest rate cut month of the century, with a total of 26 central banks implementing rate cut policies globally. This trend continued in October and November, marking the entry of global monetary policy into a new cycle. The Federal Reserve, as the most influential central bank in the world, had its two rate cuts in September and November not only have far-reaching impacts but also indicate that 2025 may see a wider range of policy easing.
Historically, rate cut cycles tend to lower the cost of money, improve the liquidity environment of the market, and thus support asset prices. However, this round of rate cuts has its uniqueness: global inflation has significantly retreated from the highs of 2022, but the risk of inflation rebound still needs to be monitored; the employment market remains relatively stable, with the unemployment rate at a healthy level of 4.1%; geopolitical situations add extra uncertainty.
Looking ahead to 2025, the market generally expects the Federal Reserve to continue cutting rates by 1-1.5 percentage points. Against this backdrop, major global central banks may follow the Federal Reserve's lead to further improve liquidity conditions. However, investors need to remain clear-headed while seizing opportunities: different asset classes may display differentiated performances during rate cut cycles, and simply following rate cuts may not yield ideal returns. It is advisable for investors to focus on structural opportunities with a thorough understanding of the fundamentals and to be cautious in their layouts in order to better navigate this new market environment.