Waving goodbye to interest rate hikes, the September rate cut has finally arrived
Powell’s speech in Jackson Hole pointed out the next steps for monetary policy. The interest rate cut has finally officially begun, a new stage, a new journey!
Key information revealed in Jackson Hole’s speech
Enhance confidence in the decline of inflation
Powell said that he is increasingly confident that inflation can steadily return to the 2% target. This statement is quite crucial, indicating that the Federal Reserve believes that its previous monetary policy to address high inflation has been effective. The reduced inflationary pressure and stable job market have given the Federal Reserve more policy choices.
The strengthening of this confidence may pave the way for future interest rate cuts. As inflation stabilizes, the Federal Reserve will have more room to adjust interest rates to support economic growth. The market may respond positively to this signal, especially in the bond and growth stock sectors.
Interpretation of the Labor Market
Powell said that the labor market is no longer as hot as before, much looser than before the pandemic. But at the same time, he also said that the Federal Reserve does not want to see the market get colder, which means that while they want to stabilize prices, they must also ensure that the job market is awesome.
This means that the Federal Reserve will handle interest rate policy adjustments cautiously and does not want to harm the job market through excessive tightening of monetary policy. This move may reduce market concerns about economic recession and support the performance of the stock market, especially consumer and cyclical stocks.
Opportunity for policy adjustment
Powell made it clear that ‘the time for policy adjustment has come,’ implying that the Federal Reserve may need to loosen monetary policy. Although he mentioned that the interest rate cut depends on the upcoming data and economic situation, both inside and outside of his words revealed that the Federal Reserve feels that the current policy is too tight and is prepared to relax it at the appropriate time.
It may intensify market expectations for interest rate cuts, especially next year. Investors may reassess their investment strategies in a high interest rate environment, focusing more on asset classes that benefit from a low interest rate environment, such as growth technology stocks and high-yield bonds.
Reduced supply chain and pandemic pressure
Powell emphasized that the pressure on the supply chain and market caused by the epidemic is gradually subsiding. These problems were the main reasons for the previous rise in inflation. Now that these problems are gradually being resolved, the downward pressure on inflation will become more significant.
The recovery of the supply chain and the rebalancing of market supply and demand mean that inflationary pressures will further ease in the future. This will make the Federal Reserve more composed in adjusting monetary policy and create a more favorable environment for global economic recovery.
Optimistic attitude towards future uncertainty
Even though Powell is more optimistic about inflation and the job market, he still emphasizes that policy makers need to maintain a low profile and be flexible. He mentioned that economists’ models cannot predict everything, and the Federal Reserve needs to continue monitoring the market and data, with policies that can be adjusted at any time.
Reflecting the uncertainty of the Federal Reserve’s future economic environment, it may indicate that policy adjustments will be gradual and data-driven. The market may remain cautiously optimistic as a result, waiting for further guidance from future data.
Which ETFs benefit the most from the interest rate cut cycle?
stock market
Stock market rebound and cyclical performance: Historically, when the Federal Reserve cuts interest rates, the stock market usually rebounds, especially in years like 1987, 1995, and 1998, which were not accompanied by severe economic downturns. Interest rate cuts often increase liquidity in the market while reducing corporate financing costs, often leading to a rise in the stock market. However, the stock market rebound will also be accompanied by fluctuations, because interest rate cuts are usually made when the economy is not awesome or there is downside risk.
Industry rotation and sector performance: When interest rate cuts occur, interest rate sensitive industries (such as real estate, finance, and consumer stocks) usually perform better. Because these industries have reduced financing costs in a low interest rate environment. But as interest rate cuts continue, technology stocks may begin to be favored, especially when people believe that the economy will improve in the future.
bond market
Yield curve and bond price: interest rate cuts usually lower short-term and long-term bond yields, leading to steeper yield curves, which is good news for long-term treasury bond, because bond prices will rise when yields fall. In addition, as inflation expectations decrease, the attractiveness of inflation protected bonds (TIPS) may decrease.
Credit bonds and high-yield bonds: Interest rate cuts usually improve the financing environment for companies, making it easier and cheaper for them to borrow money. This reduces the cost gap (credit spread) of borrowing, which is good for the high-yield bond market. But if the economy declines severely, the risk of high-yield bonds will increase because the default rate of enterprises may rise.
foreign exchange market
The exchange rate of the US dollar and global currencies: If the Federal Reserve cuts interest rates, the US dollar will depreciate, especially for countries that are still tightening their monetary policies. At this point, emerging markets and countries that rely on exporting commodities may perform better.
Capital flows and foreign exchange reserves: Interest rate cuts have caused the US dollar to fall, and international investors may seek higher yielding assets, leading to capital flows to emerging markets. However, this may also exacerbate the instability of global capital flows, especially for economies that are highly dependent on US dollar financing.
commodity markets
Gold and precious metals: Interest rate cuts usually benefit gold as they lower the cost of holding it. At the same time, the interest rate cut accompanied by the depreciation of the US dollar further pushed up the price of gold. Other precious metals such as silver may also benefit from the expected increase in industrial demand.
Crude oil and industrial metals: The interest rate cut gives the impression that the global economy will grow, and the demand for commodities such as crude oil and industrial metals may increase. However, if the economic slowdown is more severe than expected, these commodity prices may not rise.
Real estate market
Mortgage interest rates and real estate prices: Cutting interest rates directly lowers mortgage interest rates, making the real estate market more attractive. Low interest rates often stimulate people’s desire to buy houses, which may lead to a rise in housing prices, especially in markets with limited supply.
Commercial real estate and REITs: Commercial real estate and real estate investment trusts (REITs) have performed well during interest rate cuts, as financing costs have decreased and it would be even better if the rental market remained stable. But if the economy is not good, commercial real estate may face the risk of reduced rental demand.
Alternative assets and hedging strategies
Private equity and hedging strategies: The interest rate cut cycle is usually beneficial for private equity, as financing costs are reduced and leveraged buyouts or portfolio adjustments are more attractive. Hedge funds can make money from market fluctuations by utilizing flexible strategies, such as macro hedging, to seize opportunities brought about by currency and interest rate changes.
Cryptocurrency: The cryptocurrency market is relatively new, but in the past, as liquidity increased and the US dollar fell, digital currencies such as Bitcoin rose well. However, investors should be cautious about the high volatility and regulatory risks of such assets.
International and Emerging Markets
Developed markets and emerging markets: The Federal Reserve’s interest rate cuts are generally a good signal for emerging markets, as capital flows and the decline of the US dollar can support economic growth and asset price increases in these markets. However, if the global economy deteriorates, a reversal in capital flows may have adverse effects. If the policies in developed markets are different, emerging markets may also be more volatile.
Market expectations and sentiment
Expectation management and market volatility: The initiation of interest rate cuts often accompanies adjustments in market expectations. Investors’ expectations of the Federal Reserve’s path may lead to fluctuations in market sentiment, especially in situations where the path of interest rate cuts is uncertain and economic data is volatile. Investors should closely monitor changes in policy signals and economic data to cope with market risks.
During the interest rate cut cycle, increasing the allocation of long-term assets is usually a reasonable strategy:
The pricing of long-term assets is sensitive to interest rates. When interest rates decrease, the discount rate of future cash flows decreases, leading to an increase in the underlying asset. Therefore, long-term assets (long-term bonds, growth stocks, and overvalued technology stocks) often perform better during interest rate cut cycles.
In the bond market, bonds with longer maturities are more sensitive to interest rates. During interest rate cuts, holding long-term bonds can result in better capital appreciation, as the decrease in interest rates leads to an increase in bond prices. This is also the reason why investors usually increase the allocation of long-term treasury bond and highly rated corporate bonds in the interest rate reduction cycle.
The valuation of growth stocks usually depends on the expected growth of future cash flows. As the cash flows of these stocks are typically distributed over a longer period of time, their discounted value will significantly increase as interest rates decrease. Therefore, growth stocks often perform better than value stocks in interest rate cuts.
Real estate and infrastructure assets are often considered long-term assets because their income streams are relatively stable and long-lasting. Interest rate cuts have lowered financing costs, making these assets more attractive. Low interest rates often result in higher returns on real estate and infrastructure investments.
Although increasing the layout of long-term assets usually has good return potential during interest rate cutting cycles, it is also necessary to pay attention to potential risks. If the economic situation deteriorates or inflation exceeds expectations, it may lead to a reversal of market sentiment, thereby affecting the performance of long-term assets. Therefore, investors should make a balanced allocation based on their own risk tolerance and market expectations.
For ETF investors, the following ETF types and reasons may benefit:
Bond ETF
Long term treasury bond bond ETF: Powell mentioned that inflation pressure is easing, which indicates that long-term interest rates may decline. Therefore, the price of long-term treasury bond bonds may rise, and related ETFs such as iShares 20+Year Treasury Bond ETF (TLT) will benefit from it. Investors can consider increasing the allocation of such bond ETFs to enjoy the capital appreciation brought by the decrease in interest rates.
Growth stock ETF
NASDAQ 100 ETF: With the Federal Reserve hinting that the time for policy adjustment has come, market expectations for interest rate cuts have increased, which is particularly beneficial for growth stocks that rely on a low interest rate environment. NASDAQ 100 ETFs such as Invesco QQQ Trust (QQQ) may receive a premium due to their inclusion of a large number of technology stocks and other growth companies.
High Yield Bond ETF
If the expectation of interest rate decline increases, the risk premium of high-yield bonds may shrink, leading to an increase in the prices of these bonds. High yield bond ETFs such as iShares iBoxx $High Yield Corporate Bond ETF (HYG) may benefit from it and are suitable for investors seeking higher returns.
Gold ETF
The policy adjustments mentioned by Powell may depress the US dollar, especially in the context of interest rate cuts, which typically drive up gold prices. SPDR Gold Shares (GLD) and other gold ETFs are ideal choices for hedging against currency depreciation risks and inflation expectations.
Real estate ETF
Real Estate Investment Trusts (REITs) ETF: With policy adjustments and lower interest rates, the cost of real estate financing will be reduced, thereby increasing the attractiveness of the real estate market. The Vanguard Real Estate ETF (VNQ) may perform well and is suitable for investors seeking stable cash flow.
Under the expectation of interest rate cuts, long-term assets usually perform well, especially those industries with high growth potential, such as cloud computing and biotechnology. The following are recommendations for long-term ETFs in the cloud computing and biotechnology fields:
ETF recommendations in the field of cloud computing
Global X Cloud Computing ETF (CLOU): Focusing on cloud computing related companies, covering companies from Infrastructure as a Service (IaaS), Platform as a Service (PaaS) to Software as a Service (SaaS) and other fields. Invest in cloud computing companies with strong growth potential, which typically perform better in low interest rate environments because their future cash flows have a higher discounted value.
WisdomTree Cloud Computing Fund (WCLD): invests in cloud computing companies with high growth potential, especially those whose business models rely on subscription revenue. The investment portfolio of this ETF focuses on small and medium-sized growth companies, which often perform well in low interest rate environments.
ETF recommendations in the field of biotechnology
IShares Nasdaq Biotechnology ETF (IBB): covers large and medium-sized biotechnology companies listed on NASDAQ, focusing on the biotechnology and pharmaceutical sectors. The biotechnology industry typically has a long research and development cycle and enormous growth potential, therefore, in a low interest rate environment, the long-term characteristics of IBB ETFs make them have good investment prospects.
ARK Genomic Revolution ETF (ARKG): an innovative company focused on genomics, biotechnology, and related fields. This ETF is managed by the renowned ARK Investment Management and invests in companies with disruptive potential. ARKG’s investment portfolio includes some cutting-edge biotechnology companies that are expected to achieve significant technological breakthroughs and market growth in the future, making them suitable for long-term investors.
For investors who hope to benefit from the interest rate cut cycle, long-term ETFs in the fields of cloud computing and biotechnology are ideal choices. ETFs such as Global X Cloud Computing ETF (CLOU) and iShares Nasdaq Biotechnology ETF (IBB) provide extensive industry coverage.
Meanwhile, WisdomTree Cloud Computing Fund (WCLD) and ARK Genomic Revolution ETF (ARKG) focus on high growth and innovative companies. These ETFs not only perform well in low interest rate environments, but also have long-term growth potential, making them suitable for long-term investors to invest in.
For ETF investors, the above-mentioned bonds, growth stocks, high-yield bonds, gold, and real estate ETFs may be the best allocation choices. These ETFs can not only benefit from potential interest rate cuts, but also provide diversified asset classes to cope with future market volatility.
Disclaimer: The content of this article is for reference only and does not constitute investment advice. Investment carries risks, and caution is necessary when entering the market.
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