Fed's One-Shot Rate Cut Expected Amid EU Tariffs
2024-08-15 News

Fed's One-Shot Rate Cut Expected Amid EU Tariffs

A series of significant events and data have been densely unveiled overnight. First, the European Union proposed to impose additional tariffs on Chinese car exports, followed by the United States' May CPI coming in lower than expected, and then the Federal Reserve's June interest rate meeting revised down the full-year interest rate cut forecast to just one time. Global financial markets fluctuated accordingly, but the overall risk appetite actually increased, with U.S. Treasury yields and the U.S. dollar weakening, and U.S. stocks continuing to hit new historical highs.

Institutional insiders told reporters, "The 'dot plot' revised the interest rate cut for the year to only 25BP (basis points), but thanks to the cooling of the U.S. May CPI on both a year-over-year and month-over-month basis, most U.S. stocks rose; driven by the sentiment of overseas markets, the Chinese market also opened calmly on the 13th, with the automotive sector not falling but rising, the yuan slightly depreciating, and the U.S. dollar/CNH quoted around 7.26."

Patrick Hummel, Head of European Automotive Industry Research at UBS, told reporters, "For Chinese electric vehicle manufacturers, profit margins in foreign markets are often higher than in domestic markets, which means there is still some room for price cuts to partially offset the impact of tariffs. Chinese industry leaders may accelerate localization of assembly in the European Union, which has been welcomed by EU member states such as Hungary, Italy, and Spain."

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Inflation slows down, and the Federal Reserve expects one interest rate cut this year.

Recently, the various economic data in the United States have been fluctuating, leading to volatile market performance and interest rate cut expectations.

Morgan Asset Management told reporters that the U.S. CPI rose month by month in the first quarter, slowed down in April and May, but the downward trend is not yet solid. Recent employment-related data signals are mixed: ADP and Jolts employment weakened, unemployment rate increased, but the May non-farm data was stronger than expected (nearly 100,000 people stronger than the forecast), and market expectations for Federal Reserve policy have reversed several times.

Morgan Asset Management said that the Federal Reserve's June meeting maintained the policy interest rate level unchanged, and the latest economic forecast raised the inflation expectations for 2024 and 2025, while the dot plot showed that the interest rate cut for the year was revised down to only 25BP. However, thanks to the May CPI released on the eve of the interest rate meeting, U.S. stocks mostly rose overnight, and the U.S. dollar and U.S. Treasury yields fell, not affected by the interest rate meeting.

Wind data shows that the Dow Jones index fell slightly by 0.09% overnight, the S&P 500 rose by 0.85%, the Nasdaq rose by 1.53%, the U.S. dollar index fell to around 104.69, the two-year U.S. Treasury yield fell by 6BP to 4.75%, and the 10-year U.S. Treasury yield fell by 8BP to 4.31%.

In fact, the Federal Reserve's interest rate meeting this time was not dovish. Lon Erickson, Portfolio Manager at Shang Bo Investment Management, analyzed for reporters that the expected median of the federal funds rate was raised from 2.6% to 2.8%, a neutral interest rate level higher than previously expected. At the same time, the forecast median for 2024 is only one interest rate cut, lower than the previous three times, and also lower than the market's expectation of two times. The expected number of interest rate cuts in 2025 increased from three to four times previously, which means there is still an expectation of five interest rate cuts in the next 18 months.

The slowdown in inflation is obviously an important factor. Jerry Chen, a senior analyst at Gain Capital Group, told reporters that the U.S. May CPI year-over-year fell from 3.4% to 3.3% (unchanged month-over-month), and the core CPI year-over-year fell from 3.6% to 3.4%, both lower than expected, and the super core CPI monthly rate recorded a negative growth for the first time in two years. The unexpected decline in inflation has delighted the market, and the probability of an interest rate cut in September has risen to 56%.Goldman Sachs believes that the decline in prices for some consumer goods categories, including new cars, consumer electronics, clothing, and entertainment products, partly reflects the increase in discounts and promotions by retailers, a situation that is expected to continue in June. The current inflationary pressures are mainly concentrated in the service sector.

The impact of the EU tariff is limited

Compared to the Federal Reserve, EU tariffs have attracted more attention in the Chinese market. However, on the 13th, BYD's stock price not only did not fall but also rose, closing up by more than 4%, and the Shanghai Composite Index only fell slightly.

According to the European Commission's pre-disclosure, if negotiations with the Chinese government do not reach a consensus in the coming weeks, it plans to impose additional provisional countervailing duties on top of the existing 10% tariff on pure electric vehicles, specifically targeting BYD (17.4%), Geely (20%), and SAIC Motor (38.1%), effective from July 4th.

As early as May 14th, the United States announced a further increase in tariffs on imported electric vehicles, lithium batteries, photovoltaic cells, and key minerals from China, raising the tax rate to 25%~100%. However, Nomura stated at the time that the impact would be very limited, with $18 billion worth of products accounting for only 4.2% of the total imports from China by the United States and less than 1% of China's total exports, with Chinese-made pure electric and hybrid vehicles accounting for only 2% of the total imported new energy vehicles in the United States.

In comparison, the EU market accounts for a larger share, but given the strong competitiveness of Chinese electric vehicles, institutions expect the overall impact to be limited. Hummel told reporters that if the new tariffs become a final ruling, two outcomes are expected - first, the group of Chinese car manufacturers entering the EU will become more concentrated (i.e., the expansion plans of small enterprises may be thwarted), and industry leaders may continue to advance. Second, for Chinese electric vehicle manufacturers, profit margins in foreign markets are often higher than in domestic markets, meaning there is still some room for price reduction to partially offset the impact of tariffs. Chinese industry leaders may accelerate localization assembly in the EU. Even with localization assembly in Eastern Europe, Chinese leading enterprises will still have a 25% cost advantage over traditional EU car manufacturers.

The head of research and investment of an overseas fund also told reporters that the current export prices overseas are divided into several parts - landed cost price, freight, distributor channel fees, and the final end price. "The landed cost price cannot be lowered too much, otherwise there will be a risk of being investigated for anti-dumping; freight fluctuates greatly, which is beneficial for car companies like BYD that have their own ships; if the distributor channel fees are pressed too hard, it will affect their store openings and sales volume. Therefore, only the end price can be raised, which will indeed affect sales volume a bit, but the overall pressure on leading car companies is not significant." According to the reporter's understanding, in the current European market, the lowest-priced Chinese car manufacturers are SAIC MG (about 32,000 euros), BYD is about 35,000 euros, and Volkswagen is around 40,000 euros.

China's stock and foreign exchange market continues to fluctuate

Faced with external disturbances, the Asia-Pacific market as a whole remains stable. As of the close on the 13th, the Hang Seng Index in Hong Kong rose by 0.97% to 18,112.63 points, the Shanghai Composite Index fell by 0.28% to 3,028.92 points, and the Nikkei 225 Index fell by 0.40%. As of around 17:00 on the same day, the US dollar index was reported at 104.78, slightly retreating from the previous 105 range, the US dollar/CNH was reported at 7.2667, and the US dollar/CNY closed at 16:30 at 7.2520, up 17 points from the previous trading day.

It is expected that the US dollar will remain strong in the near future, and the Chinese yuan may fluctuate within the range of 7.2 to 7.3. Tommy Wu, an emerging market economist at Commerzbank, told reporters that in the past two weeks, the People's Bank of China has set the daily average midpoint of the yuan at around 7.11. Since it was below 7.0950 at the beginning of April, there has been a slight depreciation tendency recently, but the central bank still maintains exchange rate stability by setting a stronger midpoint. He also said that in the near stage, Chinese exporters have postponed the conversion of US dollars, and the recovery of outbound tourism has also led to more foreign exchange outflows. It is reported that China may manage capital outflows by guiding enterprises to purchase foreign exchange and overseas remittances or dividend payments.China's exports maintain resilience, also providing "real gold and silver" support for the exchange rate. In May, China's exports valued in US dollars grew by 7.6% year-on-year, better than the market's expected 5.7%, and higher than the 1.5% in April. "Export growth was mainly driven by shipments to ASEAN economies, with a year-on-year increase of over 20%. Exports to the United States unexpectedly recovered to moderate growth, while exports to Europe continued to be weak," said Tommy Wu.

Chinese A-shares and Hong Kong stocks are also in a range-bound mode, but the recent consolidation is not surprising. If calculated from April, the maximum increase in the Hang Seng Index once exceeded 25%, entering a technical bull market. It is expected that after the sharp rise, Hong Kong stocks are significantly overbought in the short term and have technical correction pressure. Looking at the historical bottom valuation repair pattern, the valuation repair is basically in place near 20,000 points, but the bear-bull transition is still in its early stage, and further policy benefits and earnings recovery in the third quarter are needed to open up the upward space.

As for A-shares, institutions still generally favor "China Special Valuation" and cyclical stocks. Wu Zhaoyin, the macro strategy director of AVIC Trust, told reporters that recently, "China Special Valuation" has slightly adjusted, and the leading stocks of cyclical industries have also retreated after rising. However, short-term adjustments have not weakened the ability of these companies to create value, but have provided entry opportunities for long-term investors. These companies are rooted in the vast domestic market, continuously benefiting from the structural reforms of the domestic economy and consumption upgrade trends, and have good growth potential and risk resistance. In addition, high overseas inflation and rising commodity prices have further enhanced the attractiveness of "China Special Valuation" and cyclical stocks.

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