Author: Deep Tide TechFlow

Guide

In today's ever-changing global economic landscape, the direction of the Federal Reserve's monetary policy profoundly impacts 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 interest rate cuts.

Binance Research recently released a report, providing an in-depth explanation of the Federal Reserve's interest rate policy and its impact on the economy and various asset classes.

The report systematically analyzes the relationship between core economic indicators such as interest rates, inflation, and employment, based on economic foundational theories, combined with the latest data and historical experiences. It also comprehensively dissects the performance of different asset classes such as stocks, bonds, commodities, and cryptocurrencies during interest rate cut cycles, providing clear decision-making references for investors.

Deep Tide TechFlow has summarized the key information of 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 pandemic response in March 2020. The market expects a continued interest rate cut of 1-2 percentage points in 2025, with a probability of about 62% for an additional 0.25% cut in December.

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 once 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 begun a new round of interest rate cuts.

Mechanism of Interest Rate Influence: As the 'price of money', interest rates affect the market through two main channels:

  • Lower borrowing costs, making it easier for market entities to access funds, while reducing the burden of existing debt

  • Lower risk-free returns, driving investors to seek alternative investment channels to enhance returns

Historical Trends: U.S. interest rates have shown a structural decline over the past 50 years, from 8-10% in the 1980s to near-zero rates in the 2010s, and now to over 5% in recent times.

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 such as inventory costs, lack of yields, and exchange rates

  • Bond prices are inversely related to interest rates

  • Although historical data for cryptocurrencies is limited, they have performed strongly during interest rate cut cycles, such as a 537% increase within 12 months after the interest rate cut in March 2020

Policy Shift: The curtain on global central bank interest rate cuts 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 interest rate cut since March 2020 in response to the COVID-19 pandemic. Prior to this, in response to rising inflation, the Federal Reserve conducted aggressive interest rate hikes from March 2022 to July 2023, followed by maintaining rates unchanged over eight consecutive meetings until this cut. The 0.25% cut in November further confirmed the start of a new round of interest rate cuts.

The Federal Reserve's policy actions are always centered around its dual mandate: to promote maximum employment and maintain price stability. In the post-pandemic period, prices rose rapidly, with inflation once exceeding 9% in mid-2022, prompting the Federal Reserve to initiate the strongest 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. The current market expects a reduction of 1-1.5 percentage points in 2025, with about a 62% probability for a 0.25% cut in December (with a probability of about 38% for keeping rates unchanged).

The relationship between inflation, interest rate cuts, and the broader economic system (including asset performance) is complex and worthy of in-depth attention from market participants.

It is worth noting that in 2024, several central banks around the world have already started the process of interest rate cuts, which will have a profound impact on global financial markets.

Basic Concepts: The relationship between interest rates and economic mechanisms

Warren Buffett once said, 'Interest rates drive everything in the economic universe.' Let’s 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'

  • Raising interest rates = more expensive money

  • Lowering interest rates = cheaper money

Two Major Impacts of the Current Interest Rate Cut Environment

  1. Debt and Lending Effects

    1. Businesses and institutions can obtain financing at lower costs, promoting investment expansion

    2. The interest burden of existing debt decreases, improving cash flow conditions

    3. Consumer borrowing costs decrease, stimulating consumption and housing demand

    4. Overall economic activity is boosted, contributing to economic growth

  2. Yield Effect

    1. Government bonds and other risk-free asset yields decrease

    2. Investors are forced to seek other investment channels for higher returns

    3. Equities, real estate, and other risk assets see valuation support

    4. Funds shift from low-risk assets to high-risk assets

Major Economic Variables

  1. Inflation

    1. The Federal Reserve has set 2% as the long-term target inflation rate

    2. Inflation once exceeded 9% in mid-2022

  2. Employment Situation

    1. The current unemployment rate remains at a relatively healthy level of 4.1%

    2. Non-farm payroll data is released on the first Friday of each month and is an important market indicator

  3. Market Environment and External Factors

    1. Corporate Earnings: Quarterly financial reports and expectations serve as a barometer of market confidence

    2. Regulatory Policies: Attitudes toward financial innovation regulation, including cryptocurrencies (as shown in the following image, the number of cryptocurrency-friendly individuals in the U.S. House and Senate has significantly increased during elections represented by green)

    3. Geopolitics: External shocks from international trade relations, regional conflicts, etc.

    4. Macroeconomic Indicators: Including trade balance, consumer confidence, PMI, etc.

Historical Perspective: Past Federal Reserve interest 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: Close to zero interest rate levels

  • Recent: Increased to over 5%

  • September and November 2024: A new round of interest rate cuts begins

Historical performance of various assets

  1. Stock Market (S&P 500)

  • Overall Trend: Generally rising after interest rate cuts

  • Specific Performance:

    • First Interest Rate Cut in September 1984: 3 months +1%, 6 months +9%, 12 months +14%

    • Interest Rate Cut in July 1995: 3 months +6%, 6 months +13%, 12 months +22%

    • Special Cases: Negative returns in 2001 and 2007 (during economic recession)

      • January 2001: 12 months -12%

      • September 2007: 12 months -18%

  1. Commodities

  • Influencing Factors:

    • Inventory Costs: Interest rates affect holding costs

    • Return Characteristics: No fixed income

    • Dollar Exchange Rate: Commodities are mostly priced in dollars

  • Inflation Association:

    • Usually seen as a leading indicator of inflation

    • Commonly used as an inflation hedge

  1. Bonds

  • Core Characteristics: Significantly inversely related to interest rates

  • Operating Mechanism:

    • Rising interest rates → bond prices fall

    • Falling interest rates → bond prices rise

  • Ten-year Treasury yield: Highly correlated with the federal funds rate

  1. Cryptocurrency

  • Historical Data: Only experienced two rounds of interest rate cuts (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:

    • Sample period is relatively short

    • Market size is relatively small, volatility is high

    • Affected by multiple factors, not limited to interest rate changes

This historical review shows that while interest rate cuts typically support asset prices, specific performances vary by asset class and macro environment. Especially during economic recessions, 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 solely based on whether rates are cut.

Conclusion: The global interest rate cut cycle has begun, presenting both opportunities and challenges for the market

As the report shows, 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 into 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, saw its two interest rate cuts in September and November not only having far-reaching effects but also signaling a potential for wider policy easing in 2025.

From historical experience, interest rate cut cycles tend to lower the cost of money, improve market liquidity conditions, and subsequently 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 job market remains relatively stable, with 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-minded while seizing opportunities: different asset classes may exhibit differentiated performance during interest rate cut cycles, and simply following rate cuts may not yield ideal returns. Investors are advised to pay attention to structural opportunities with a thorough understanding of fundamentals and to proceed cautiously in positioning to better cope with this new market environment.