Article source: Deep Tide TechFlow
Written by: Deep Tide TechFlow
Introduction
In today's ever-changing global economic landscape, the direction of the Federal Reserve's monetary policy affects global financial markets. In September 2024, the Federal Reserve cut interest rates for the first time since 2020, initiating a new round of interest rate cuts.
Binance Research recently released a report detailing the background of the Federal Reserve's interest rate policy and its impact on the economy and various asset classes.
The report analyzes the relationship between core economic indicators such as interest rates, inflation, and employment from the perspective of economic fundamental theory, combining the latest data and historical experience. It also provides a comprehensive analysis of the performance of different asset classes such as stocks, bonds, commodities, and cryptocurrencies during the interest rate cut cycle, offering clear decision-making references for investors.
Deep Tide TechFlow has summarized the key information from this report, as follows.
Key points
Latest interest rate cut dynamics: The Federal Reserve announced a 0.5% interest rate cut in September 2024, followed by a further 0.25% cut in November, marking the first interest rate cut since the COVID-19 response measures in March 2020. Prior to this, in response to rising inflation, the Federal Reserve implemented aggressive rate hikes from March 2022 to July 2023, followed by maintaining rates unchanged for eight consecutive meetings until this rate cut. The 0.25% cut in November further confirmed the initiation of the new round of interest rate cuts.
Policy background analysis: The Federal Reserve adheres to the principle of 'dual mandate', committed to promoting maximum employment and maintaining price stability (inflation target of 2%). In mid-2022, inflation briefly exceeded 9%, prompting the Federal Reserve to take aggressive interest rate hikes, raising rates to the highest level in 20 years. As inflation gradually cools, the Federal Reserve has initiated a new round of interest rate cuts.
Interest rate impact 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 entities to obtain funding while reducing the burden of existing debt
Lowering risk-free yields compels investors to seek other investment channels to enhance returns
Historical trend: U.S. interest rates have shown a structural decline over the past 50 years, dropping from 8-10% in the 1980s to nearly zero in the 2010s, and recently rising above 5%.
Asset performance analysis:
The stock market (S&P 500) generally trends upward after interest rate cuts, but exceptions may occur during economic recession periods
The relationship between commodities and interest rates is complex, influenced by multiple factors such as inventory costs, lack of yields, and exchange rates
Bond prices have a clear inverse relationship with interest rates
Although historical data for cryptocurrencies is limited, they perform strongly during interest rate cut cycles, such as a 537% increase within 12 months after the March 2020 interest rate cut
Policy shift: The global central bank interest rate cut has begun
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 interest rate cut since the COVID-19 response in March 2020. Prior to this, to combat rising inflation, the Federal Reserve aggressively raised rates from March 2022 to July 2023, then kept rates unchanged for eight consecutive meetings until this cut. The 0.25% cut in November further confirmed the start of the new round of interest rate cuts.
The Federal Reserve's policy actions revolve around its dual mandate: promoting maximum employment and maintaining price stability. In the post-pandemic period, prices rose rapidly, and inflation briefly exceeded 9% in mid-2022, prompting the Federal Reserve to initiate the most aggressive interest 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 has begun to shift towards easing. Current market expectations suggest a potential interest rate cut of 1-1.5 percentage points in 2025, with a probability of approximately 62% for a 0.25% cut in December (the probability of maintaining rates is about 38%).
The relationship between inflation, interest rate cuts, and the broader economic system (including asset performance) is complex and deserves the attention of market participants.
It is worth noting that multiple central banks around the world have begun the interest rate cut process in 2024, a trend that will have far-reaching implications for global financial markets.
Basic concept: The mechanism of interest rates and economic operation
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 affect economic operations.
Basic principles of interest rates
Core definition: Interest rates are essentially the 'price of money'
Higher interest rates = more expensive money
Lower interest rates = cheaper money
Two major impacts of the current interest rate cut environment
1. Debt and borrowing effects
Businesses and institutions can obtain financing at lower costs, promoting investment expansion
The interest burden of existing debt decreases, improving cash flow conditions
Consumer borrowing costs decline, stimulating consumption and housing demand
Overall economic activity has been boosted, contributing to economic growth
2. Yield effect
Yields on risk-free assets such as government bonds are declining
Investors are forced to seek other investment channels to achieve higher returns
Valuations of risk assets such as stocks and real estate are supported
Funds are shifting from low-risk assets to high-risk assets
Major economic variables
1. Inflation
The Federal Reserve set a long-term target inflation rate of 2%
In mid-2022, it briefly exceeded 9%
2. Employment situation
Current unemployment rate remains at a relatively healthy level of 4.1%
Non-farm employment data is released on the first Friday of each month, an important market indicator
3. Market environment and external factors
Corporate profits: Quarterly financial reports and expectations are barometers of market confidence
Regulatory policy: The regulatory attitude towards financial innovations, including cryptocurrencies (as shown in the chart, the number of crypto-friendly individuals in the U.S. House of Representatives and Senate has significantly increased)
Geopolitics: External shocks such as international trade relations and regional conflicts
Macro indicators: Including trade balance, consumer confidence, PMI, etc.
Historical perspective: Past Federal Reserve interest rate cut cycles and asset performance
Interest rate change trend
Over the past 50 years, U.S. interest rates have shown a structural decline:
1980s: Maintained at high levels of 8-10%
2010s: Near zero interest rate levels
Recent: Rising above 5%
September and November 2024: Initiating a new round of interest rate cuts
Historical performance of various assets
1. Stock market (S&P 500)
Overall trend: Generally rising after interest rate cuts
Specific performance:
September 1984 first interest rate cut: 3 months +1%, 6 months +9%, 12 months +14%
July 1995 interest rate cut: 3 months +6%, 6 months +13%, 12 months +22%
Special situations: Negative yields during 2001 and 2007 (economic recession periods)
January 2001: 12 months -12%
September 2007: 12 months -18%
2. Commodities
Influencing factors:
Inventory costs: Interest rates affect holding costs
Yield characteristics: No fixed income
Dollar exchange rate: Commodities are often priced in dollars
Inflation correlation:
Often considered a leading indicator of inflation
Commonly used as an inflation hedge
3. Bonds
Core characteristics: Clearly inversely related to interest rates
Operating mechanism:
Interest rates rise → bond prices fall
Interest rates fall → bond prices rise
10-year Treasury yield: Highly correlated with the federal funds rate
4. Cryptocurrencies
Historical data: Only experienced two rounds of interest rate cut cycles (second half of 2019 and March 2020)
Performance highlights:
July 2019 interest rate cut: 12 months +25%
March 2020 interest rate cut: 12 months +537%
Special considerations:
Short sample period
Relatively small market size, high volatility
Affected by multiple factors, not limited to interest rate changes
This historical review shows that while interest rate cuts usually support asset prices, the specific performance varies by asset class and macro environment. Especially during economic recession periods, even rate cuts may not prevent asset prices from falling, reminding investors to consider multiple factors comprehensively rather than simply making investment decisions based on whether rates are cut.
Conclusion: The global interest rate cut cycle has begun, with opportunities and challenges in the market
As the report indicates, September 2024 became the fourth largest interest rate cut month of this century, with a total of 26 central banks globally implementing interest rate cut policies. This trend continued in October and November, marking a new cycle in global monetary policy. The Federal Reserve, as the most influential central bank in the world, saw its two interest rate cuts in September and November have profound implications and foreshadow a broader policy easing in 2025.
Historically, interest rate cut cycles often reduce the cost of money, improve market liquidity conditions, and thus support asset prices. However, this round of interest rate cuts has its uniqueness: global inflation has significantly retreated from its peak in 2022, but the risk of inflation rebound still needs to be monitored; the labor market remains relatively stable, with an unemployment rate maintaining 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 stay alert while seizing opportunities: different asset classes may exhibit differentiated performance during interest rate cut cycles, and simply following the interest rate cuts may not yield ideal returns. It is recommended that investors pay attention to structural opportunities and cautiously position themselves based on a full understanding of the fundamentals to better cope with this new market environment.