Dear all,
September saw extended rallies across stocks, bonds, and gold. The S&P 500, Dow Jones, and Sensex continued to reach new highs. The bond market saw broad-based gains as prices of corporate and government bonds both rallied. Meanwhile, the USD remained weak, and gold prices hit record levels.
Fed Goes Big with Timely Rate Cut to Support Economic Soft Landing
The most significant event of the month was undoubtedly the FOMC meeting, the outcome of which can be summed up as “proactive while maintaining a positive outlook.” Besides the generous half-point cut, the dot plot is also projecting a path of further easing that could see another 200-250 bps of rate reduction, which would bring rates to the Taylor Rule’s suggested levels (requiring a further reduction of 175 bps). The Summary of Economic Projections (SEP) was also crucial. Is the aggressive first cut preemptive or recessionary?
In September’s SEP, the Fed not only lowered its inflation outlook but also maintained its GDP growth forecast at 2%, again signaling inflation is no longer a concern, and the focus is now on sustaining economic growth above the longer-run average of 1.8%.
Furthermore, although the Fed did not announce any changes to the pace of balance sheet drawdown, I believe there’s no cause for concern, as the decision conveys two key messages:
- The Fed is managing market expectations, indicating it still has the option to slow and even reverse its balance sheet runoff if an economic crisis arises in the future.
- This also indicates market liquidity remains ample. Looking at liabilities on the Fed’s balance sheet, while deposits at the overnight reverse repo (ON RRP) facility continue to decline, the Treasury General Account (TGA) balance has climbed to about $800 billion.
Remember back in August, the Treasury lowered its Q4 end-of-quarter TGA cash balance target to just $700 billion? This suggests that the Treasury has more than enough funds for Q4, and the likelihood of further reducing debt issuance is thus quite high, which is also conducive to liquid financial conditions.
Underlying Fundamentals Held Up, No New Signs of Weakness in Economic Data
Economic data released in September has held up. Nonfarm payrolls increased by 142,000, just above the passing grade. Meanwhile, the key indicators we recommended monitoring closely, including the layoff rate, jobless claims, and the share of reentrants and new entrants in the unemployed population, have not risen further, also translating into better-than-expected retail sales performance. On the liquidity front, the latest Q3 data for the net proportion of banks tightening lending standards shows a sharp decline, while the net proportion of banks reporting stronger lending demand has risen significantly. Rate cut expectations have begun to materialize, as reflected in bank lending. Overall, we should continue monitoring employment data over the next 1~2 months to see if it stabilizes under the auspices of the timely rate cut.
Manufacturing also remains a key area of our focus. The MM Manufacturing Cycle Index has started to decline, driven by developments in key economies, including Europe, where the manufacturing PMI slipped from 45.8 to 44.8 in September; China, where mid-month data missed expectations; and Taiwan, where export growth, a key indicator of global chip demand, is slowing, sliding to 9.85% in July and August, down from the double-digit growth seen in the first half of the year.
After assessing data over the past quarter, supported by the AI productivity boom, we think a more neutral scenario of single-digit export growth is more likely for Q4, with continued AI momentum and a seasonal uptick in consumer demand, though a massive wave of device upgrades is unlikely. Consequently, stock markets more sensitive to manufacturing and chips, such as those in Taiwan, South Korea, and the PHLX Semiconductor Index, have also seen increased volatility and stock rotation.
Market Outlook and Allocation Strategy
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