The Federal Reserve will once again disrupt the global market! The outlook for China's stocks and bonds is divergent

On Thursday, February 1, Beijing time, the Federal Reserve will announce its latest interest rate decision. Since the Fed's dovish signal at the end of last year, the market has been aggressive in its expectations for interest rate cuts, once betting on a 160bp rate cut in 2024 (the Fed is only expected to cut rates 3 times). However, strong U.S. economic data has since lowered interest rate cut bets.

Therefore, it is particularly important whether the Fed's first interest rate meeting this year can point out the direction of the interest rate path for the whole year. "The Fed is widely expected to keep interest rates unchanged this month and continue its monthly balance sheet reduction process by keeping interest rates unchanged and continuing the $95 billion monthly balance sheet reduction process due to recent strong economic data suggesting that the probability of a soft landing is rising, and the Red Sea crisis could lead to a recurrence of global inflation. The market expects the probability of a rate cut in March to be around 50%, which is much lower than the nearly 80% a month ago, and the expectation of a rate cut for the whole year has also dropped from 160BP to about 125BP. Expectations of aggressive rate cuts are undergoing revisions. Jerry Chen, a senior analyst at StoneX, told the first financial reporter.

If the Fed maintains its cautious rhetoric this time, it may consolidate the trend of a phased rebound in the dollar index. However, any hint of a rate cut and an end to balance sheet reduction would trigger a sell-off in the US dollar, which would be positive for US and emerging market equities.

The Fed will lead the market

While it is only a matter of time before a rate cut is made, it has been strong US economic data that has made the market nervous recently, which means that the timing of the rate cut may be delayed. After the last interest rate meeting, Goldman Sachs expects to start cutting interest rates in March.

The recently announced US GDP growth in the fourth quarter of 2023 was 3.3% quarter-on-quarter, far exceeding market expectations of 2%. The Fed's favorite core PCE price index fell to 2.9% in December from 3.2%, below expectations of 3%. The weakening of inflationary pressures, combined with solid economic growth, has hovered around 50% for the Fed to cut interest rates in the first half of the year, helping the dollar index to rise for four consecutive weeks.

At the same time, retail sales data was particularly strong. According to the data, the US retail sales data in December 2023 increased by 0.6% month-on-month, double the previous value of 0.3%, exceeding market expectations of 0.4%, the largest increase in three months.

"U.S. consumer spending remains very strong, which could add to inflationary pressures. I think what's happening in the Middle East is also going to raise some concerns, and if supply chains are affected, it will increase inflationary pressures, and that concern will continue. Jerry Chen said.

In addition, the US non-farm payrolls data, which will be released on Friday, will also be crucial. The market expects 173,000 new jobs in January, compared with 216,000 in the previous month, the unemployment rate rose slightly from 3.7% to 3.8%, and the year-on-year growth rate of hourly earnings remained unchanged at 4.1%.

Overall, manageable inflation (close to the Fed's target) and a stable job market (below 4% for an extended period of time) make rate cuts less urgent and potentially magnitative.

About one-quarter of the S&P 500 will also report results this week, including Microsoft, Google, Apple, Amazon, Meta, ExxonMobil, Chevron and many others. Institutions generally believe that Tesla, one of the "Big Seven" of technology, is still an exception last week when its performance fell sharply short of expectations, because the price war for electric vehicles is becoming increasingly fierce, so even though Tesla has delivered a record number of vehicles, its net profit has been squeezed.

"Even if the other Big Seven may find some weaknesses, I think it could only be that Apple will be weak. "But broadly speaking, especially for companies that are investing more in AI, such as Microsoft, they have the potential to continue to bounce back." We saw the Nasdaq break above 17,000 points. It has only met a little resistance, having previously been slightly below 17,700 points, and the bulls will expect the index to reach the level of 18,000 points. The only thing to note is the Relative Strength Indicator, which has just entered the overbought zone and may experience consolidation for the time being. ”

Foreign investors prefer Chinese bonds over A-shares

For Chinese assets, the Fed's signal cannot be ignored.

From the perspective of international investors and global monetary policy, institutions generally believe that 2024 will be a favorable year for China, when the US dollar interest rate is higher, funds tend to flow out of the Chinese stock market, and when the US dollar interest rate is lower, funds tend to flow back to the Chinese stock market.

According to an interview with the first financial reporter, major international institutional investors generally believe that they currently prefer RMB bonds, while A-shares need to observe further policy support and profitability, and the RMB exchange rate against the US dollar is expected to remain stable.

As China's economy has yet to stabilize, the bond market is booming, after the yield on 10-year Chinese government bonds fell below 2.5%. As of the close of trading on January 30, the yield on 10-year Treasury bonds was as low as 2.485%, and institutions expect that there is still downside potential.

Huang Qingfeng, senior investment strategist of fixed income at AllianceBernstein, told reporters a few days ago: "We are currently optimistic about domestic Chinese government bonds, and in an environment of moderate inflation, the People's Bank of China currently has a lot of room to continue to cut the reserve requirement ratio and interest rates." We believe that there is a possibility of a 50bp RRR cut this year, and we do not rule out further increases, and there may be one or two opportunities for interest rate cuts throughout the year, which will be positive for the performance of Chinese government bonds; ”

At present, there is a combination strategy that is also favored by foreign investors. Zhang Meng, a macro and foreign exchange strategist at Barclays, told reporters: "A popular combination is to hold a USD/RMB 1-year foreign exchange swap, which is still in a deep negative range (US dollar investors can make a profit through the swap itself), and use the RMB exchanged for the swap to hold 10-year Chinese government bonds, which can bring about 60~80BP of carry income after considering the cost of US dollar funds." ”

As far as A-shares are concerned, investors are still waiting to see what will happen next. Recently, China has indeed stepped up its stimulus. The central bank will cut the reserve requirement ratio by 50bp on February 5, releasing 1 trillion yuan of long-term liquidity. This is the largest RRR cut since December 2021. The central bank also announced targeted "interest rate cuts", which will reduce the relending and rediscount rates for rural and small and micro enterprises by 25bp from January 25. In addition, in December 2023, policy banks added 350 billion yuan of net new collateral supplementary loans (PSL), mainly to support the "three major projects".

Barclays also mentioned that Central Huijin may have bought 10 billion yuan worth of ETFs tracking the tech stock index in October last year, after it bought about $65 million in shares of China's largest bank. There have been recent signs that buyers led by state-owned institutions are buying ETFs that track a number of major indices to cushion the market's decline, which can also be seen in the surge in transaction value.

However, Fidelity believes that after the outflow of foreign capital in 2023, the selling pressure of foreign capital that has been underweight A-shares is declining. "In the macro environment where the 'policy bottom' is clear, the market will wait for more detailed rules to land. Zhou Wenqun, manager of Fidelity Fund Equity Fund, told reporters, "The three quarterly reports of A-shares last year showed that the overall profit growth rate bottomed out. Provided that subsequent stimulus is appropriate, we expect earnings growth to pick up to high-single-digit levels from a low base this year. ”

In terms of specific layout, Zhou Wenqun said that he is optimistic about high-dividend varieties with stronger certainty, including energy, utilities, transportation, banking and telecommunications. In December last year, the China Securities Regulatory Commission (CSRC) introduced a series of new rules to encourage listed companies to pay dividends, buy back and improve shareholder returns, laying a good foundation for enhancing the long-term attractiveness of A-shares. More listed companies are expected to increase their dividend payouts, so the attractiveness of high-dividend sectors is expected to increase in an environment of uncertainty about the economic recovery.

Zhou Wenqun said that he is also optimistic about Chinese overseas enterprises with obvious global competitive advantages, such as home appliances, tools and construction machinery industry leaders, which are gradually developing from local enterprises to global enterprises. At the same time, considering the new cycle demand brought about by emerging technology products, the replacement cycle brought about by Chinese smartphone brands after regaining market share, and the golden stage of automotive intelligence, growth sectors in line with the direction of economic transformation such as consumer electronics, semiconductors, and automotive electronics have also attracted attention.

In addition, as the economy and earnings bottom out, many institutions said that they will also choose opportunities to allocate pro-cyclical sectors with low valuations, including consumption, materials and industrials, according to the pace of recovery.

The renminbi will be range-bound

As of 18:40 on January 30, USD/CNY was quoted at 7.179, maintaining a range-bound pattern. At present, the institution's forecast for the RMB exchange rate in 2024 is in the range of 7.0~7.2.

In the short term, traders believe the renminbi may come under pressure. On the one hand, the U.S. economic data is still strong, making it difficult for the U.S. dollar index to weaken, and on the other hand, the market has taken profits after some stimulus policies have been implemented, and macro adjustments and earnings pressures persist.

"We expect USD/CNY to consolidate between 7.1 and 7.2. A series of positive developments have contributed to the RMB's recent one-off rally, but a strong US dollar could make it difficult for the RMB to rise above 7.1. Zhang Meng told reporters that although the central bank has been committed to maintaining the stability of the exchange rate, "we are not aware of the intention to maintain the exchange rate below 7.1." ”

Standard Chartered recently said that the views of the surveyed SMEs on the exchange rate of the RMB against the US dollar in the next three months tend to be different. Most companies expect the RMB to remain stable against the US dollar, but the proportion of respondents who expect appreciation and depreciation to increase by 2 percentage points from the previous month to 12.6% and 9% respectively. At the same time, more SMEs surveyed said that the USD/RMB exchange rate trend since January has helped reduce corporate financial costs.

(Intern Di Yang also contributed to this article)