Written by: Deep Tide TechFlow
Introduction
In today's rapidly changing global economic landscape, the direction of the Federal Reserve's monetary policy influences global financial markets. In September 2024, the Federal Reserve cut rates for the first time since 2020, beginning a new round of interest rate cuts.
Binance Research recently released a report that delves into the origins of the Federal Reserve's interest rate policy and its impact on the economy and various assets.
This report systematically analyzes the relationships among core economic indicators such as interest rates, inflation, and employment, based on economic fundamental theories, incorporating the latest data and historical experiences. It also provides a comprehensive analysis of the performance of different asset classes such as stocks, bonds, commodities, and cryptocurrencies during interest rate cut cycles, 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% cut in September 2024, followed by a further 0.25% cut in November, marking the first rate cut since the measures taken in response to COVID-19 in March 2020. The market expects a continuation of rate cuts by 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 the principle of 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-hiking measures, raising rates to the highest level in 20 years. As inflation gradually cools, the Federal Reserve has begun a new round of interest rate cuts.
Interest rate impact mechanism: Interest rates act as "the price of money", and their fluctuations will affect the market through two main channels:
Lower borrowing costs make it easier for market participants to obtain funds while reducing the burden of existing debt
Lower risk-free yields drive investors to seek other investment channels to enhance returns
Historical trend: U.S. interest rates have shown a structural declining trend over the past 50 years, from 8-10% in the 1980s to nearly zero interest rate levels in the 2010s, and then to over 5% recently.
Asset performance analysis:
The stock market (S&P 500) generally shows an upward trend after rate cuts, but exceptions may occur during recession periods
The relationship between commodities and interest rates is more complex, influenced by multiple factors such as inventory costs, lack of yield, and exchange rates
Bond prices have a significant inverse relationship with interest rates
Although historical data on cryptocurrencies is limited, they performed strongly during interest rate cut cycles, such as a 537% increase in the 12 months following the March 2020 rate cut
Policy shift: The curtain has risen on global central bank interest rate cuts
On September 18, 2024, the Federal Reserve lowered the federal funds rate target range by 0.5 percentage points to 4.75-5.00%, marking the first rate cut since responding to the COVID-19 pandemic in March 2020. Prior to this, to address rising inflation, the Federal Reserve had aggressively raised rates from March 2022 to July 2023, then maintained the rate constant for eight consecutive meetings until this cut. The 0.25% rate 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 period, prices rose rapidly, and inflation once broke 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 has begun to shift towards easing. The current market expects a rate cut space of 1-1.5 percentage points in 2025, with a probability of approximately 62% for a 0.25% cut in December (with a probability of maintaining the current rate at 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.
Notably, multiple central banks around the world have begun the interest rate cut process in 2024, a trend that will have far-reaching effects on global financial markets.
Basic concept: Interest rates and economic operation mechanisms
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"
Rising interest rates = more expensive money
Lowering interest rates = cheaper money
Two major impacts of the current interest rate cut environment
Debt and lending effects
Businesses and institutions can obtain financing at lower costs, promoting investment expansion
The interest burden of existing debt is reduced, improving cash flow conditions
Consumer borrowing costs decline, stimulating consumption and housing demand
Overall economic activity is boosted, contributing to economic growth
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 set a long-term target inflation rate of 2%
In mid-2022, it 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, an important market indicator
Market environment and external factors
Corporate profits: Quarterly earnings reports and expectations are a barometer of market confidence
Regulatory policies: Attitudes towards financial innovations including cryptocurrencies (as shown in the figure below, the number of crypto-friendly individuals in the House and Senate in the U.S. significantly increased)
Geopolitics: External shocks from international trade relations, regional conflicts, etc.
Macroeconomic indicators: Including trade balance, consumer confidence, PMI, etc.
Historical perspective: Past Federal Reserve interest rate cut cycles and asset performance
Trends in interest rate changes
U.S. interest rates have shown a structural declining trend over the past 50 years:
1980s: Maintained at a high level of 8-10%
2010s: Approaching zero interest rate levels
Recent: Rising to over 5%
September and November 2024: A new round of interest rate cuts begins
Historical performance of various assets
Stock market (S&P 500)
Overall trend: Generally rising 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 recession periods)
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
Dollar exchange rate: Commodities are mostly priced in dollars
Inflation correlation:
Usually regarded as a leading indicator of inflation
Commonly used as an inflation hedging tool
Bonds
Core feature: A significant inverse relationship with interest rates
Operational mechanism:
Rising interest rates → Bond prices fall
Falling interest rates → Bond prices rise
Ten-year Treasury yield: Highly correlated with the federal funds rate
Cryptocurrency
Historical data: Only experienced two rounds of interest rate cut cycles (in 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
Market size is relatively small and volatile
Affected by multiple factors, not limited to interest rate changes
This historical review shows that while interest rate cuts usually support asset prices, specific performances vary by asset class and macro environment. Especially during recession periods, even interest rate cuts may not prevent asset prices from falling, which suggests that investors need to consider multiple factors comprehensively rather than making investment decisions based solely on whether rates are cut.
Conclusion: A global interest rate cut cycle has begun, with both opportunities and challenges in the market
As the report shows, September 2024 became the fourth largest rate cut month of this century, with a total of 26 central banks globally implementing rate cuts. 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 far-reaching implications for its two rate cuts in September and November, and it also indicates that 2025 may see broader policy easing.
From historical experience, interest rate cut cycles often reduce the cost of money, improve market liquidity, 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 inflation rebound risks still need to be monitored; the job 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 Fed's lead, further improving the liquidity environment. However, while investors seize opportunities, they also need to remain clear-headed: different asset classes may demonstrate differentiated performance during interest rate cut cycles, and simply following rate cuts may not yield ideal returns. It is recommended that investors focus on structural opportunities with a comprehensive understanding of fundamentals and make cautious layouts to better cope with this new market environment.
