The Strong Comeback of the Dollar: Economic Logic and Market Outlook Behind the Fed's Rate Cuts|Moomoo research

In the current economic environment, the Federal Reserve's policy direction has become increasingly influential on the market, particularly following the September 17th meeting where the Fed decided to lower its policy interest rate by 50 basis points to a target range of 4.75-5.0%. This move exceeded the market's widespread expectation of a 25 basis point cut, generating significant attention. The meeting minutes revealed three key insights: first, there are notable divisions within the Fed regarding the extent of the rate cut. While a substantial majority of officials supported the 50 basis point reduction, some argued that a 25 basis point cut would have been more appropriate. Their justification lies in the backdrop of falling inflation and a persistently weak labor market, necessitating a more aggressive monetary policy response.

Secondly, the Fed reiterated that future monetary policy will rely on economic data trends; if inflation continues to decline, the policy rate will gradually return to neutral levels. This perspective was echoed in Powell's recent remarks, indicating that the Fed is not in a hurry to implement rapid rate cuts. Lastly, participants emphasized that a 50 basis point cut should not be interpreted as an increased risk of economic recession, but rather as a careful assessment of the economic fundamentals.

At the same time, the fundamentals of the U.S. economy exhibit a degree of resilience. Although the unemployment rate has risen since April 2023, the labor market remains robust, and inflation is steadily approaching its target. Fed staff predict that the real GDP growth rate will near its potential growth rate in the coming years, with the unemployment rate revised upward to 4.4% for 2024. These data points suggest that, amid expectations of an economic soft landing, market anticipation for rate cuts is cooling.

However, the dollar's performance has surprised the market. Typically, the fourth quarter is a period of weaker dollar performance, but since October, the dollar has strengthened rapidly. The rebound in U.S. Treasury yields and the dampening of rate cut expectations from the Fed are undoubtedly significant factors driving the dollar's strength. The widening interest rate differential between the dollar and the euro indicates that the euro may face further depreciation pressures. The U.S. economy's performance has significantly exceeded expectations, particularly with September's non-farm payroll data surpassing market forecasts, leading to a gradual reduction in expectations for rate cuts this year.

It's noteworthy that the market's prior overzealous betting on rate cuts may also lead to a rebound. From a risk-reward perspective, the current low U.S. Treasury yields do not offer an ideal risk-return ratio, prompting a shift in investor expectations for the future. Furthermore, conflicts in the Middle East are driving up oil prices, and the market is closely watching the upcoming CPI data; if this month's data exceeds expectations, it could have a substantial psychological impact on the market.

China's ongoing large-scale economic stimulus measures have also somewhat heightened market expectations for inflation. Meanwhile, the significant rise in Hong Kong dollar interest rates may create a "siphoning effect" for dollar assets. Given that a large amount of Hong Kong dollar funds have flowed into U.S. fixed-income products over the past few years, the recent boom in Hong Kong stocks could lead to some funds withdrawing from U.S. fixed income markets, potentially putting pressure on U.S. Treasuries.

In summary, the interdependent relationship between U.S. and Chinese asset pricing will be a focal point for market observation. The strength of the dollar complements the resilience of the U.S. economy, while adjustments to Fed policy will continue to attract close scrutiny. We expect that, as economic data evolves, the Fed will implement rate cuts of 25 basis points each in November and December, with a continuing trend of rate cuts expected, ultimately bringing the policy rate down to a range of 3.25%-3.5%. In this context, investors should stay alert to market dynamics and adjust their investment strategies in response to the ever-changing economic landscape.