Fed Cuts May Boost China's Markets Temporarily, Long-Term Benefits Should Be Tempered | Insights

Chongqing - The U.S. Federal Reserve recently slashed interest rates by 50 basis points amid cooling inflation and a weakening labor market, marking the first rate cut in four years.

In an exclusive interview with Bridging News on September 22, Pu Yongjian, Professor at the School of Economics and Business Administration, Chongqing University, noted that while the rate cut may offer a short-term lift to China's financial markets, expectations of long-term benefits should be tempered.

Pu Yongjian, Professor at the School of Economics and Business Administration, Chongqing University. (Photo/Pu Yongjian)

Hong Kong stocks show stronger short-term resilience 

The Fed’s substantial rate cut will impact global financial markets, leading to a weaker USD and a stronger CNY. While the narrowing China-U.S. interest rate gap may attract international capital to China, Pu noted that this won’t necessarily result in a large-scale influx of foreign investment.

Pu added that multinational corporations' efforts to diversify risks and adjust supply chains may lessen the appeal of interest rate differentials for capital inflows. Without significant policy changes in China, the long-term decline in foreign investment will likely persist, though speculative capital might briefly slow the rapid outflows between 2022 and 2024.

As the interest rate gap narrows, short-term speculative capital may flow into China, lifting asset prices and boosting the stock market. With the A-share market currently at historic lows, foreign investors could find it appealing, especially amid rate cuts and recession risks in developed economies. This influx may improve capital liquidity, temporarily increase A-share trading volume, and facilitate a gradual recovery in market valuations.

Pu believes Hong Kong's stock market may demonstrate stronger short-term resilience than the mainland. With its exchange rate pegged to the U.S. dollar, the Fed’s rate cut had an immediate effect. On the announcement day, the interest rate-sensitive Hang Seng Tech Index surged by 3.25%, reflecting a swift and strong market response to the decision.

Southbound capital inflows into Hong Kong hit a three-year high, with mainland Chinese enterprises contributing 78.4% of market value and 85.3% of trading volume as of August 2024. This highlights the rate cut’s positive short-term impact on China’s economy via the Hong Kong market.

With the significant rate cut, both A-shares and Hong Kong stocks are expected to benefit sectors that thrive on improved liquidity, such as growth, manufacturing, and small to mid-cap industries. In the short term, investors may focus on the financial sector, while medium-term opportunities are likely in growth areas like autonomous tech, the digital economy, consumer electronics, pharmaceuticals, and high-end manufacturing, including automotive.

Expert predicts sequential rate cuts 

As the China-U.S. interest rate gap narrows, reduced capital outflow risks give China more room for monetary easing, potentially leading to further reserve requirements and interest rate cuts. This would boost domestic liquidity, lower financing costs, and support the real estate market.

Pu even noted that the Fed's interest rate cut may prompt some investors to withdraw funds from other markets and shift to the U.S. market for higher returns. This trend could lead to capital outflows from China, putting pressure on the RMB exchange rate and impacting China's foreign trade and investment structure.

The Shanghai Securities News analyzed that reductions typically began with 25 basis points in past Fed rate cut cycles, making a 50 basis point cut appear unusual. Jerome Powell, Chairman of the Federal Reserve, indicated that the cut was precautionary, with future actions contingent on economic data could lead to accelerating, slowing, or pausing further rate cuts.

In response, Pu predicts that the Fed will continue with sequential rate cuts, stating, "I anticipate 1-2 rate cuts by the Fed in 2024 and 4-5 cuts in 2025 for two main reasons." 

First, despite 29 months of rate hikes and 12 months at 5.25%-5.5%, the U.S. economy has remained resilient, largely due to the financial support during the pandemic, which preserved purchasing power, sustained consumer demand, and enabled business expansion and job growth.

Secondly, based on the Fed's history of adjusting interest rates, the initial two changes were exploratory in nature, and this adjustment is unlikely to be any different.