From December twenty-third, two thousand twenty-four, to December twenty-sixth, two thousand twenty-four

I. Foundation 

resistance to change and hence greater dependability for the results shown in the past.

Three major patterns in rate-cut cycles with soft landings

When analyzing central bank behavior, focusing on marginal changes in unemployment data and the extent to which the policy rate deviates from neutral provides clearer policy signals, especially when a cycle is nearing its end or economic growth is slowing.

G10Central bank rate-cutting behavior during historical soft landings can provide a key reference for soft-landing rate-cut cycles.

First, policy is usually front-loaded in the early part of a rate-cut cycle, with a more cautious pace afterward.On average, 50% of the rate cuts are completed within six months of the first cut (80% within a year). The pace of rate cuts gradually slows from 1.1 pp over the first 3 months to 0.7 pp over the final 3 months.

In addition, Rate-cut cycles in which cuts pause for at least three months account for as much as 70%, and nearly half of the cycles include more than one pause.This indicates that Soft-landing rate-cut cycles are often long (cycles lasting more than a year account for 50%) and tend to follow a “fast first, slow later” pace, with central banks more inclined to make cautious, incremental adjustments as they approach the terminal rate.

Second, rising unemployment and a policy rate that is high relative to the neutral rate are important factors affecting the continuation of a rate-cut cycle.Since the start of rate cuts, each 1 pp increase in unemployment raises the probability of continued rate cuts by 40 pp, while each 1 pp overshoot in the policy rate adds 25 pp to the likelihood of continued rate cuts. By comparison, Changes in core inflation and GDP growth have a significantly weaker influence on rate-cut decisions.

Third, In historical soft-landing episodes, central banks usually cut the policy rate below neutral.At the end of a rate-cut cycle, the policy rate is on average 1 pp below the neutral rate, with the distribution skewed to the downside. Further regression analysis shows that rising unemployment is the main driver of central banks cutting rates below neutral.

Specifically, each increase of 1 percentage points in unemployment raises the probability of cutting rates below neutral by more than 20 percentage points, while GDP growth and inflation have little predictive power for whether a rate-cut cycle ends at a restrictive or accommodative level.

Overall, Rising unemployment is the strongest predictor of continued or deeper rate cuts.Regression analysis indicates that when unemployment rises, central banks are more likely to cut rates below neutral.

2024.12.24

A year of divergence in global macro trading (36 key charts)

Regional convergence trades still lack a clear catalyst. Although the market vividly remembers the moves of 2017, a similar recurrence is less likely. Next year will be a year of divergence in global macro trading.

1) The sustainability of the reflation trade?

2) Current bond yields and fiscal deficit levels are very different from those in 2016.

3) Fed rate cuts are usually positive for emerging markets, but the question is how much more they can cut.

4) At the same time, the dollar's trajectory is also crucial...

5) ...this is not a view that applies only to emerging markets

6) Uncertainty over tariff policy still needs to be resolved... China continues to face structural headwinds.

7) U.S. small caps have already gone through a recession...

8) ...the valuation gap with large caps could narrow...

9) In 6, small caps outperformed large caps after two and a half years of weakness

10) Small caps have underperformed large caps by more than the median peak-to-trough drawdown in previous cycles...

11) In addition to cheaper valuations, rate cuts will also be a catalyst for small and mid caps.

12) Equity valuations have not provided a cushion for the bond market, even when calculated on an equal-weighted basis...

13) ...the key remains momentum in earnings per share (EPS)... the correlation between earnings and price-to-earnings ratios (P/E) has consistently been positive.

14) Weak prices and slowing revenue growth will constrain earnings growth.

15) The main risks to expectations that consumption will remain resilient in 25 come from changes in trade, immigration policy, fiscal cuts, and the labor market...

16) The U.S. labor-market indicator for “jobs plentiful” is declining...

17) Wage growth is slowing, while mortgage payment costs are rising.

18) The bond yield curve is expected to steepen further

19) Excessive equity-market positioning is not limited to institutional investors...

20) Can sidelined capital become a major source of support?

21) At the index level, SX5E (the Euro Stoxx 50 index) has been consolidating since 3... this could continue for longer...

22) ...the eurozone may continue to underperform the United States.

23) The rally driven by stimulus in the East is fading...

24) Many cyclical sectors, especially those related to the East, have performed poorly this year...

25) In addition to revisions to earnings expectations and the impact of tariffs, in soft-landing scenarios cyclical sectors typically rebound around 6-8 months after the Fed starts cutting rates...

26) Despite the poor performance of cyclical sectors throughout the summer, their valuations remain significantly higher than those of defensive sectors...

27) Defensive sectors typically perform better when bond yields are low.

28) The U.S. market may outperform the eurozone and emerging markets, but regional convergence trades may gradually emerge as 2025 progresses.

29) Eurozone valuations are attractive, but whether earnings growth can be achieved remains uncertain; meanwhile, China's M1 growth is weak.

30) The Japanese market was overweighted in 2022 12, and Wall Street chose to add to positions on the pullback.

31) The U.K. market is valued cheaply and may also prove relatively resilient during periods of market volatility.

32) U.S. bank stocks have more supporting factors than European bank stocks and are better positioned from here.

33) Within the technology sector, trading is gradually shifting from semiconductors to software. Continue to select high-quality technology stocks and stay away from unprofitable areas.

34) U.S. economic exceptionalism remains the base case, but some concerns remain...

35) ...unlike at the beginning of 2023, when most people viewed a recession as the base case, which instead brought positive surprises; now, market consensus seems overly complacent...

36) ...some of the favorable factors supporting consumer spending may gradually weaken...

2024.12.26

U.S. consumers' exposure to imports from China

Since the first round of tariffs imposed by the Trump administration, the share of U.S. goods imports coming from China has fallen from its peak of 18% to 11% today. Although the overall amount has declined, the United States remains highly dependent on China in several consumer-goods categories.

Chinese imports as a share of U.S. consumer-goods 7% of producer value(excluding transportation, wholesale, and retail costs and margins), accounting for 3.3% of final consumer spending on goodsAmong these, about 80% consists of direct imports of consumer goods, while the remaining 20% is made up of intermediate goods and raw materials.

In addition, although Chinese imports contribute relatively little in services, when goods and services are combined, Chinese imports account for approximately 1.4% of U.S. core consumer spending.

First, The United States is particularly dependent on imports in certain product categories

The chart above shows that Chinese imports account for more than 80% of total U.S. imports in household-goods categories such as household appliances, furniture, and footwear, while China's share of global exports in these categories also exceeds 60%, far more than that of any other country. In the short term, it will be difficult to replace this high level of dependence with other exporting countries, as alternative suppliers may not have sufficient capacity.

Second, Producer-value perspective

Chinese imports have a significant share in durable goods and some nondurable goods, including glassware and tableware (23%), household appliances (24%), footwear (30%), as well as phones (39%) and photography equipment (24%) in the consumer electronics sector, These categories are the most sensitive to tariff policy, and tariff increases have the greatest direct pass-through to prices.

If tariffs are fully passed on to consumers, prices of Chinese goods could rise by 2%-10%, with the increases concentrated in categories such as kitchenware, household appliances, luggage, recreational goods, footwear, and computer equipment.Even after taking the weighted average across all sources of production into account, U.S. consumer prices' overall increase would still be between 1%-2%。

This also means The tariffs themselves have a relatively limited impact on U.S. core PCE prices.According to GS's forecast, higher tariffs on imports from China will increase core PCE prices by about 0.24%; including automobile tariffs, the overall increase in core PCE prices would be in the range of about 0.3%.

2024.12.26

II. Insights 

Our Viewpoints and ideas on market.

Discussing another possibility for last Wednesday

Technical indicators show that the U.S. stock market is now clearly in oversold territory, laying the groundwork for a potential rebound. Historically, the probability of a year-end rally is about 76%, and market sentiment points to an optimistic outlook for year-end.

Some time has passed since the Fed's remarks on Wednesday. It did, for the most part, deliver on its promises; what really frightened the market was the dot plot for the future that was released afterward.In retrospect, there may actually have been another possible explanation for this market move.

For several months before Wednesday, U.S. stocks had been caught in an extremely unhealthy, highly concentrated trade. Although the market seemed calm, as noted in recent notes, The U.S. stock market is now in a portfolio rebalancing period.

The past two weeks were precisely when all domestic mutual funds were rebalancing their portfolios and making annual allocations, therefore, given that this negative bias in the market had already been present, The market on Wednesday may have needed only a small nudge for sellers who needed to reduce their positions to start selling.

The reason for raising this possibility is that, looking back from today, Last week's sell-off actually occurred across all asset classes: assets with gains were sold, and all assets with losses were sold as well。Here is the key question: if the market was really trading the Fed's revised dot plot and expecting inflation to prove more persistent, then Gold should not have plunged nearly 2.5% on Wednesday.

If the Fed was really saying that inflation was persistent and would rise, Wednesday should have been a big up day for gold. But that was not what happened: assets across the board moved in the same direction. In that situation, it is more likely that portfolio-rebalancing flows were using the news as a pretext.

Bonds were sold, stocks were sold, gold was sold, Bitcoin was sold; everything was sold.All profitable assets were sold to rebalance and make allocations, while all losing assets were removed from the books.

It is reasonable to think and expect that many investment managers were in fact waiting for the Fed's action on Wednesday, The market needed only a reason to sell. Everybody was on one side of the boat, and I needed to clear the deck.

If this is the scenario, the market should continue to rebound. Reallocation buying would provide a foundation for a year-end rally through the end of the year; historically, the year-end rally does indeed usually begin on the day before Christmas.

2024.12.23

Sources of downside risk next year

So far, the market has interpreted every piece of bad news as good news because the Fed will cut rates.

In during the rate-cutting cycle, this good-news trade will continue, because there will continue to be plenty of optimism, at least in the first half of the year, such as expectations of Fed rate cuts, more business-friendly tax policies under the new administration, and potential support for infrastructure, among other things.

The main issue is that, if the economy slows more than expected next year (not a recession, just a slight slowdown),if the slowdown that is highly likely to occur in the economy next year actually happens, the micro-level earnings rationale underpinning the U.S. stock market will no longer hold.

Additionally, date X will most likely fall between 7 and -9 next year; see:https://mp.weixin.qq.com/s/SXwaTPRwELUko7I8MyRW7A(if the United States abolishes the debt ceiling)

In fact, many economies around the world outside the United States—the euro area, the United Kingdom, Asia, and Japan—are growing at rates close to recession levels, and are growing only marginally. Meanwhile, U.S. economic growth is 3.2%, far outpacing nearly every other country. This is why U.S. equities have attracted substantial inflows.But this anomaly—the growth gap between other countries and the United States—is unsustainable.

Either other countries will step up broadly and begin to accelerate their growth to catch up with U.S. economic growth, or U.S. growth will slow to converge with theirs (This scenario is more likely), because the current U.S. economic interaction mechanism remains one of importing disinflation and exporting inflation. Over the coming year, the United States will import disinflationary pressure from the global economy, This also means that U.S. economic growth will inevitably slow unless there is another major stimulus bill or another type of infrastructure spending bill.

See:

1) Notes 24-12-16 U.S. stocks enter late-cycle trading https://www.meridianresearch.app/notes/7ef1c4bf-4eb9-4bc2-af82-a8e2a9f9eabc?ref=769bd1d1-1bdb-461a-89c9-e42c1ff5beebView note

2) Notes 24-10-31 In the U.S. stock market, micro-level earnings matter more than macro factors:https://www.meridianresearch.app/notes/75a9cbf5-8715-4f56-8722-9ee9c33dc638?ref=769bd1d1-1bdb-461a-89c9-e42c1ff5beebView note

2024.12.23

Next year's monetary easing is underpriced

Expectations for monetary policy easing have cooled markedly. Fed funds futures are currently pricing in less than 40bp in rate cuts for 2025, a sharp downgrade from expectations of 125bp following the 50bp rate cut in 9.

Much of the adjustment is justified, but it has been too aggressive.

1) Market expectations for easing in 2025 have fallen sharply

2) But the inflation rebound has in fact been exaggerated

3) Tariff risks are also overpriced, and the price shock is likely to be a one-off

From a monetary policy perspective, first, If there are no significant second-round effects through wages or inflation expectations, the effect on inflation of a one-off rise in the price level caused by tariffs will disappear after about a year, bringing it in line with the repeated VAT increases in other G10 economies, which generally leave no lasting mark on inflation or monetary policy.

Second, the trade war that took place in 2018-2019 The trade war tightened financial conditions, prompting the Fed to ease. There are many differences in this cycle, but past experience suggests that the monetary policy risks from tariffs are at least two-sided.The monetary policy risks from tariffs are at least two-sided.

4) It is too early to declare the labor market stable

5) The European downturn may be deepening

In addition to slow productivity growth, high energy prices, and intensifying competition from the East, the risk of punitive U.S. tariffs is also looming. Trade policy uncertainty has surged since the U.S. election, while manufacturing indicators have weakened further; this could increase the likelihood of an industrial recession in the euro area.​

6）Cushion the Hit from Higher US Tariffs？

Overall, the US-Europe divergence is largely priced in, and equities and credit will most likely continue to deliver positive returns, but given current high valuations, low hedging costs, and the risk of a seasonal downdraft around the New Year, it may be appropriate to increase hedge allocations appropriately.

The real trade-weighted dollar is currently at its strongest level of the floating exchange rate era, second only to the peak before the 1985 Plaza Accord. Despite the Fed’s ongoing hawkish repricing, EM rates markets have remained relatively resilient, and long opportunities in Central and Eastern Europe may be worth watching.

We continue to expect oil and natural gas to trade within a range and metals to diverge (iron ore may fall further), while copper and gold Gold may perform more strongly.

2024.12.24

III. Market Pulse 

Our latest Comments on the economic and market environment

Leveraged Loan Default Spike

US junk loan default rates are rising at their fastest pace in four years, reflecting the full emergence of the aftereffects of the post-pandemic wave of low-cost borrowing. According to Moody’s data, over the 12 months through 10, the default rate in the global leveraged loan market (predominantly U.S.) rose to 7.2%, its highest level since the end of 2020.

Compared with high-yield bonds, the default rate on junk loans is rising more sharply,Riskier companies are more inclined to use floating-rate leveraged loans.The excess debt issuance during the pandemic amid low interest rates is now facing the severe test of high borrowing costs. Although the Fed has begun cutting rates, the impact of borrowing cost pressures on the market cannot be ignored.

This trend may continue through 2025. On the one hand, high borrowing costs continue to penalize companies; on the other, lender protections have weakened further with the prevalence of covenant-lite structures. Moody’s notes that in 2024, many lower-rated companies were unable to raise financing in public or private markets and had to restructure their debt, causing the leveraged loan market’s default rate to far exceed that of the high-yield bond market.

More concerning, distressed exchanges have accounted for more than half of this year’s default events, the highest proportion on record.Although this type of transaction avoids outright bankruptcy, it effectively reduces lenders’ recovery rates. Many asset-light companies (such as those in healthcare and software) lack sufficient asset backing, so their recovery rates in default may be lower.

Even so, the high-yield bond market spread remains at a historic low since 2007, showing that investors’ appetite for yield remains strong; this “exuberance” may be disconnected from actual market risks.

In the short term, as the Fed’s rate-cutting cycle advances, borrowing costs may ease, giving companies some breathing room, and default rates in both the high-yield bond and leveraged loan markets may stabilize. But S&P Global’s Ruth Yang believes that loose loan terms merely postpone the problem rather than solve it fundamentally。

2024.12.25

Note: All content herein is for reference only, does not constitute investment advice, and is not a basis for any laws, regulations, or regulatory policies. Investors should not use or rely on this information as a basis for making decisions.