Author: Shenchao 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, marking the beginning of a new round of rate cuts.
Binance Research recently released a report that delves into the origins and impacts of the Federal Reserve's interest rate policy on the economy and various asset classes.
The report systematically analyzes the relationships among core economic indicators such as interest rates, inflation, and employment, starting from foundational economic theory, combined with 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 rate cut cycle, offering clear decision-making references for investors.
Shenchao TechFlow organized the key information from 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 since the COVID-19 pandemic response measures in March 2020. The market expects a continued rate cut of 1-2 percentage points in 2025, with a probability of about 62% for another 0.25% cut in December.
Policy Background Analysis: The Federal Reserve adheres to the "dual mandate" principle, 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 rate hike measures, increasing rates to the highest level in 20 years. As inflation gradually cooled, the Federal Reserve began a new round of rate cuts.
Interest Rate Impact Mechanism: Interest rates, as the "price of money", will influence 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
Lowering the risk-free yield drives investors to seek alternative investment channels to increase returns
Historical Trend: U.S. interest rates have shown a structural decline over the past 50 years, from 8-10% in the 1980s to nearly zero in the 2010s, and then recently above 5%.
Asset Performance Analysis:
The stock market (S&P 500) generally shows an upward trend after rate cuts, but exceptions may occur during economic recessions
The relationship between commodities and interest rates is complex, influenced by inventory costs, lack of yields, exchange rates, and other factors
Bond prices are clearly inversely related to interest rates
Cryptocurrencies, although historical data is limited, performed strongly during rate cut periods, such as a 537% increase within 12 months after the March 2020 rate cut
Policy Shift: The curtain has been raised on global central banks' rate cuts
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 the pandemic response began in March 2020. Prior to this, to combat rising inflation, the Federal Reserve had implemented aggressive rate hikes from March 2022 to July 2023, followed by maintaining rates during eight consecutive meetings until this rate cut. The 0.25% cut in November further confirmed the start of a new round of rate cuts.
The Federal Reserve's policy actions always revolve around its dual mandate: to promote maximum employment and maintain price stability. In the post-pandemic period, prices rose rapidly, with inflation exceeding 9% in mid-2022, which prompted 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 cooled, the Federal Reserve began to shift towards easing. Current market expectations indicate a potential rate cut space of 1-1.5 percentage points in 2025, with a probability of about 62% for a 0.25% cut in December (keeping rates unchanged has a probability of about 38%).
The relationship between inflation, rate cuts, and the broader economic system (including asset performance) is complex and deserves the attention of market participants.
It is noteworthy that multiple central banks globally have begun the rate-cutting process in 2024, and this trend will have far-reaching effects on global financial markets.
Basic Concept: Interest rates and the economic operating mechanism
Warren Buffett once said: "Interest rates drive everything in the economic universe." Let's start from the most basic concept 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 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 decrease, stimulating consumption and housing demand
Overall economic activity is boosted, contributing to economic growth
Yield Effect
The yield on risk-free assets such as government bonds declines
Investors are forced to seek alternative investment channels for higher returns
Valuation of risk assets such as stocks and real estate is 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%
Inflation once exceeded 9% in mid-2022
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 financial reports and expectations serve as a barometer of market confidence
Regulatory Policies: Regulatory attitudes towards financial innovations, including cryptocurrencies (as shown in the diagram below, the number of crypto-friendly individuals in the U.S. Congress has 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 rate cut cycles and asset performance
Interest Rate Change Trends
Over the past 50 years, U.S. interest rates have shown a structural decline:
1980s: Maintained at high levels of 8-10%
2010s: Approaching zero interest rate levels
Recent: Rising to above 5%
September and November 2024: A new round of rate cut cycle begins
Historical performance of various asset classes
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 in 2001 and 2007 (during economic recession)
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 Association:
Typically regarded as a leading indicator of inflation
Commonly used as an inflation hedge
Bonds
Core Characteristics: Clearly inversely related to interest rates
Operating Mechanism:
Interest rates rise → Bond prices fall
Interest rates fall → Bond prices rise
Ten-year government bond yield: Highly correlated with the federal funds rate
Cryptocurrency
Historical Data: Only experienced two rounds of rate-cutting cycles (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, with greater volatility
Affected by multiple factors, not just limited to interest rate changes
This historical review shows that while rate cuts typically provide support for asset prices, 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 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 this century, with a total of 26 central banks globally implementing rate cut policies. This trend continued through October and November, marking the beginning of a new cycle of global monetary policy. The Federal Reserve, as the most influential central bank globally, with its rate cuts in September and November, not only has far-reaching impacts but also signals a potential for broader policy easing in 2025.
From historical experience, rate cut cycles often reduce the cost of money, improve market liquidity conditions, and thus provide support for asset prices. However, this round of rate cut cycle has its uniqueness: global inflation has significantly receded from its peak in 2022, but the risk of inflation rebound must still be guarded against; the labor market remains relatively stable, with the unemployment rate at a healthy level of 4.1%; geopolitical situations add additional uncertainties.
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 exhibit differentiated performances during the rate cut cycle, and simply following rate cuts may not yield ideal returns. It is recommended that investors focus on structural opportunities and exercise caution in their layouts to better navigate this new market environment.
