In May, the US CPI data fell below expectations again, and investors have begun to anticipate that the Federal Reserve may cut interest rates soon.

Interest rates are one of the most important macro Indicators, which can affect the potential trends in the prices of various Assets, including Stocks, Bonds, Commodities, and more.

If the Federal Reserve really starts a rate-cutting cycle, how should investors deploy their strategies?

This article will help organize the direction of the Federal Reserve's monetary policy and which Assets may benefit from the Federal Reserve's rate-cutting policy.

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When will the Federal Reserve cut interest rates?

Starting from March 2022, in order to curb rising inflation, the Federal Reserve began a cycle of interest rate hikes. After 11 rate increases, the level of interest rates in the United States has risen from the zero interest rate era to the current 5.25%-5.50%.

The inflation level in the United States has indeed fallen as expected. The latest CPI data released in the United States shows that the CPI for May 2024 is 3.3%, lower than the expected 3.4%, and has significantly decreased from 6% at the beginning of 2023, now closely approaching the Federal Reserve's 2% target.

So when will the Federal Reserve lower interest rates? This can be observed from two aspects: one is the Fed's dot plot, and the other is the market observation tool, the CME FedWatch Tool.

1. From the perspective of the Federal Reserve, the signals released here are quite hawkish. From the recently published June 'dot plot,' the committee members now believe there will only be one rate cut in 2024. More precisely, the median expectation for the number of rate cuts this year has been lowered from three in March to only one, with four members expecting no rate cuts this year, which is two more than in the last dot plot.

2. From the market's perspective, the expectations for a rate cut are somewhat more optimistic. According to data from the CME FedWatch Tool, the market currently estimates a 31.3% probability of one rate cut by the end of 2024, a 43.6% probability of two rate cuts, and a 17.7% probability of three rate cuts (assuming each rate cut is 25 basis points). This indicates that the market currently leans towards two rate cuts in 2024, with the first rate cut possibly occurring in either September or November this year.

How to allocate Assets in the context of a rate cut?

A reduction in interest rates by the Federal Reserve could have a positive impact on U.S. Stocks, U.S. Bonds, and Gold among other Assets. Here, a detailed analysis will be provided for each:

U.S. Stocks

For the overall U.S. stock market, interest rate cuts may have a positive impact on overall valuations.

U.S. stock valuations are very sensitive to interest rates because when Wall Street values a company, it often uses the DCF model, which is the discounted cash flow method.

The principle of DCF, simply put, is that the value of a company can be assessed through two indicators: one is the company's future cash flows, and the other is the discount rate. The discount rate is generally calculated from the risk-free rate set by the Federal Reserve.

Assuming that the company's future cash flows are fixed, the higher the discount rate, the less the present value translates to. Conversely, the lower the discount rate, the more the future earnings of the company will translate to present value.

Therefore, an interest rate cut by the Federal Reserve may help enhance the overall valuation of the stock market.

Although an interest rate cut by the Federal Reserve is beneficial for the overall stock market, the level of bullishness brought by the cut varies across different sectors.

According to a report by Fidelity, small-cap stocks and cyclical stocks may have greater potential opportunities during interest rate cut cycles for the following reasons:

Small-cap stocks: The impact of interest rate cuts on small-cap stocks may be greater than on large-cap stocks because small companies tend to rely more on short-term debt, and a rate cut would greatly alleviate their burden.

Cyclical Stocks: Generally speaking, cyclical stocks are more sensitive to interest rates, and a decrease in interest rates is more beneficial for the operation of cyclical stocks, which may enhance profitability. These cyclical sectors include Technology, Consumer Discretionary, Real Estate, and the Financial Industry.

U.S. Bonds

The ongoing interest rate hikes by the Federal Reserve have the most direct impact on Bonds, while conversely, if the Federal Reserve cuts rates, the benefits for Bonds will also be the most direct.

This is because the price of Bonds is inversely proportional to market interest rates. In simple terms, when Bond yields fall, Bond prices rise.

However, the transmission of the Federal Reserve's interest rate to U.S. Bonds yields is not linear.

According to the prediction by Morningstar's Analysts, the Federal Reserve's rate-cutting cycle may begin in 2024, with expectations that the Federal Reserve's rate will drop from 4.85% in 2024 to 1.72%.

Correspondingly, for the 10-year U.S. Bond yield, they forecast a decline from 3.6% in 2024 to 2.75% in 2027. It can be seen that the drop in U.S. Bond yields is less than the potential cut by the Federal Reserve.

Gold

Gold is also one of the assets influenced by interest rates.

The continuous increase in interest rates in the United States has raised the risk-free rate, causing a large amount of USD funds to flow back to the United States, driving the surge of the USD.

In contrast, if the United States begins to cut interest rates, the risk-free rate will decrease, and a large amount of USD funds may flow out of the United States, leading to a decline in the USD.

Since gold is priced in USD, a decline in the USD may lead to an increase in gold prices.

However, this is only one of the attributes influencing gold prices, specifically its currency attribute. There are many other factors affecting gold prices, such as financial attributes, commodity attributes, and hedging attributes.

Compared to US bonds, gold is influenced by more factors, making its subsequent trends more difficult to predict.

How to invest in these assets?

For ordinary investors, directly investing in US stocks, US bonds, and gold may not be very convenient. For example, investing in US stocks may involve stock selection issues, while US bonds and gold may not be easy to trade directly.

For investors with little experience and limited time, it is possible to consider tracking the corresponding Assets through ETFs.

Through the ETF Sector on Futubull, investors can easily find ETFs that track various Assets.

As mentioned earlier, interest rate cuts may have a positive impact on cyclical sectors such as Technology, Consumer Discretionary, Real Estate, and the Financial Industry.

Investors can easily find ETFs that track the corresponding Industry through the ETF Heat Map feature on Futubull.

Take the Technology Sector as an example, the specific path is: Market > ETF > Heat Map > Industry > Technology

It can be seen that the largest ETF tracking Technology Industry Assets is the NASDAQ 100 ETF (QQQ), which primarily tracks the NASDAQ 100 Index, and its index constituents mainly include Technology companies such as Apple (AAPL), Microsoft (MSFT), and NVIDIA (NVDA).

For Bonds and Gold, investors can also find relevant symbols through the ETF Section on Futubull.

Taking U.S. Treasuries as an example, investors can easily find ETFs that track U.S. Treasury Bonds through the thematic ETF feature on Futubull.

The specific path is: Market > ETF > Thematic ETF > US Treasury Bond ETF.

It can be seen that the largest ETF tracking US Treasury assets is the 20+ Year US Treasury ETF (TLT), which mainly holds underlying assets of US Treasuries with maturities of over 20 years. Therefore, the price of this ETF is inversely related to the interest rates of 20-year US Treasuries. In other words, if the interest rates of 20-year US Treasuries decline, the price of TLT may rise.

It is worth noting that although these ETFs track corresponding assets, different ETF structuring methods may lead to variations in the constituent stocks within these ETFs, resulting in differing trends.

Additionally, past performance is not the only metric for evaluating ETFs; factors such as liquidity, fees, and others should also be considered for comprehensive analysis. Furthermore, past performance cannot predict future results, and investment should be approached with caution regarding market risks.

Potential Risks

Overall, the Federal Reserve's interest rate cuts have a positive impact on US Stocks, Bonds, and Gold, but this does not mean that the prices of these assets will definitely perform well after the rate cuts. There are many potential risks involved:

• Interest rates are just one of the factors influencing the prices of various assets; many other factors also affect asset prices. Taking US Stocks as an example, if a company is priced using the DCF model, the company’s future cash flow is one of the influencing factors on its value. If the US economy declines, the company’s future cash flow will also decrease, leading to a drop in the company’s value.

• Furthermore, it was previously mentioned that the market currently has a relatively optimistic expectation for rate cuts. If the Federal Reserve's rate cut does not meet expectations, it may lead to a decline in the prices of these assets.

• Finally, the Federal Reserve's optimistic expectations for interest rate cuts may have already been priced into the assets' prices. If future interest rate cuts by the Federal Reserve only meet expectations or do not exceed expectations, it may also lead to a decline in asset prices.

Investors need to fully consider their financial situation and risk preferences in order to tailor an investment strategy that suits them.

Risk Disclosure: This content does not constitute a research report, is for reference only, and should not be used as the basis for any investment decision. The information contained herein is not a comprehensive description of the securities, markets, or developments mentioned. Although the sources of information are considered reliable, the accuracy or completeness of the above content is not guaranteed. Furthermore, there is no guarantee regarding the accuracy of any statements, viewpoints, or forecasts provided in this article.