The long-anticipated interest rate cuts by the Federal Reserve have finally come to fruition, triggering a myriad of reactions across global markets.

In the early hours of September 19, 2024, Beijing time, the Federal Reserve announced its latest rate decision, reducing the target range for the federal funds rate by 50 basis points to 4.75%-5.00%. The Fed also hinted at another potential cut of 50 basis points later this year.

Just hours after the Fed’s announcement, the Hong Kong Monetary Authority followed suit, cutting its benchmark interest rate by 50 basis points to 5.25%, effective immediately.

Subsequently, major global markets experienced volatility

The US stock market initially surged but then retreated, with the S&P 500 ending its impressive seven-day winning streak, closing down by 0.29%. The Dow Jones Industrial Average fell by 103.08 points, or 0.25%, to settle at 41503.10, while the Nasdaq Composite dropped 54.76 points, a decline of 0.31%. Interestingly, US Treasury yields rose collectively, and the dollar index saw a rebound after initial declines.

In terms of Chinese assets, after the market opened on September 19, the three major A-share indices initially dipped slightly but quickly reboundedBy the close, the Shanghai Composite Index was up by 0.69%, the Shenzhen Component Index climbed 1.19%, and the ChiNext Index rose by 0.85%. The Hang Seng Index in Hong Kong posted an even stronger increase, rising 2% for a five-day winning streak, with the Hang Seng Tech Index gaining 3.25%.

Other markets in the Asia-Pacific region also reflected a positive trend, with Japan's Nikkei 225 rising by 2.13% and South Korea's KOSPI increasing by 0.21%.

Xue Junsheng, head of economic research at Hang Seng Bank, noted that the Fed's decision indicates the beginning of a rate-cutting cycle in the United States

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Despite existing uncertainties regarding US interest rates, the direction is becoming clearerAnalysis of projections from various Fed officials reveals confidence in the US economy's resilienceEven with the onset of rate cuts, expectations for accelerated easing over the next two years remain consistent, with a forecast of a cumulative reduction of 100 basis points by 2025 and another 50 basis points by 2026.

As we enter this new era of lower interest rates, the question arises: how will the flow of capital change? Will the relatively undervalued Hong Kong and A-shares attract more foreign investment, marking the beginning of a rebound?

The unexpected 50 basis point cut

The market has been eagerly awaiting the first rate cut from the Federal Reserve in four years.

The last time the Fed reduced rates was on March 16, 2020, in response to the economic disruption caused by the COVID-19 pandemic

Following that, the Fed began raising rates in March 2022, with the most recent increase occurring in July 2023, which included a series of four consecutive hikes of 75 basis points.

China Life Asset Management pointed out that the market had anticipated this rate cutSince October 2023, trading was already reflecting expectations of a Fed rate reductionHowever, higher-than-expected inflation data at the beginning of 2024 led to fluctuating expectationsFrom the perspective of employment and inflation, the recent systematic downgrade in US employment figures and a persistent rise in the unemployment rate indicate signs of a weakening labor market.

Before the Fed’s September meeting, there was a divergence in market expectations regarding whether the rate cut would be 50 or 25 basis points.

Industry insiders generally believe that the recent US economic data has been positive, including stronger-than-expected retail sales figures for August, prompting the Fed to initiate the rate cut cycle with a more aggressive 50 basis points to steer the economy towards a "soft landing."

CICC, in its latest research report, noted that a 50 basis point starting point for a rate cut cycle is quite rare, with only three instances since the 1990s—January 2001, September 2007, and March 2020.

UBS Wealth Management's investment director stated that the Fed’s 50 basis point cut is deeper than those of other major central banks

Fed Chair Jerome Powell emphasized that the Fed is committed to maintaining a strong economy rather than worrying about an impending recession, with confidence in achieving the inflation target of 2% sustainably to facilitate the beginning of the rate cut cycle.

The Federal Reserve is a latecomer to the global easing cycle; the European Central Bank has already cut rates twice, as have central banks in Switzerland, Sweden, Canada, New Zealand, and the UKHowever, Powell emphasized that the Fed does not perceive itself as lagging behindHe stated that the US economy remains robust with a strong labor marketDespite the initial cut being 50 basis points, the committee is currently “not in a hurry” to lower rates further.

According to UBS, historically, the US market has performed well when interest rates are cut during a non-recession period, and this time is unlikely to be an exception

UBS continues to forecast the S&P 500 to rise to 5900 by the end of the year and to 6200 by the end of June 2025.

Impacts on A-shares and Hong Kong stocks

The Fed’s rate cuts have opened up policy space for China, but regarding the impact on A-shares and Hong Kong stocks, most interviewees stated that it is crucial to monitor the Chinese government’s commitments and implementations of stable growth policies, along with changes in fundamental dataThey generally agreed that Hong Kong stocks, being more sensitive to external liquidity, will likely reflect the rate cuts more rapidly than A-shares due to the linked exchange rate system.

In fact, prior to the Fed's rate cut announcement, the Hang Seng Index had experienced four consecutive days of increases, continuing with a 2% rise on September 19, culminating in a total increase of 835.8 points from September 12 to September 19.

CICC's research report mentioned that Hong Kong stocks have greater resilience compared to A-shares, considering how overseas easing transmits through the markets.

Moreover, Hong Kong stocks have better earnings relative to their valuation and more thorough positioning, which also supports their performance advantage

Similarly, sectors sensitive to interest rates, like biotech and technology hardware, along with those with high overseas dollar financing components, as well as local dividends and real estate in the Hong Kong market, may benefit marginally from the rate cuts.

Regarding the performance of the Chinese market during previous "preventive" rate cut cycles, CICC noted that since 1990, there have been six Fed rate cuts, three of which were "preventive" and three were "relief" cutsIn the cases of the three preventive cuts, the Hong Kong market overall trended upward, reflecting gains over 20% in the instances of 1995-1996 and 1998. However, during the three preventive cuts, the A-shares did not consistently portray a unified up or down trend.

Why do Hong Kong stocks and A-shares behave differently during rate cuts? The reasons are primarily twofold

First, preventive cuts by the Fed enhance global liquidity, prompting foreign investors to seek higher-yielding assets, thus resulting in significant inflows into the Hong Kong marketSecond, given that Hong Kong operates as an offshore market under a linked exchange rate system with the US dollar, Hong Kong’s asset valuations are significantly influenced by Fed policies and dollar liquidity, making them more sensitive to the Fed’s rate cuts.

Interest rate declines boost Hong Kong's economic growth

Beyond the differences in A-shares and Hong Kong stock behavior due to rate cuts, the anticipated decline in interest rates is expected to support ongoing economic growth in Hong Kong.

Hong Kong’s Financial Secretary, Paul Chan, remarked that the initiation of the rate cut cycle could bring cautiously positive impacts to the Hong Kong economy

Under the linked exchange rate system, Hong Kong's interest rates will closely follow US rates, alleviating previously tight monetary conditions and easing pressures on business operations while supporting fixed asset investmentsFurthermore, as the US reduces rates, the HKD exchange rate may soften, potentially attracting tourists which benefits local consumption and retail food and beverage sectorsHowever, the actual rate reduction in Hong Kong may not perfectly align with that of the US, influenced by capital flows and market sentiment.

Lee Tat Wong, Vice President of the Hong Kong Monetary Authority, stated at a press conference that the US rate cut cycle has just begun, and rates are expected to remain relatively high for some timeThere are still many uncertainties regarding future rate cuts in the US, depending on inflation data and other factors, making it critical for investors to remain alert to global market risks