December twenty-third, two thousand twenty-four to December twenty-seventh, two thousand twenty-four

I. Foundation 

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

Three main patterns of rate-cutting cycles in soft landings

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

G10 Central banks’ rate-cutting behavior during historical soft landings can provide a key reference for rate-cut cycles in a soft landing.

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

In addition, In as many as 70% of rate-cutting cycles, cuts were paused for at least three months, and nearly half of the cycles included more than one pause.This indicates that soft-landing rate-cutting cycles tend to be long (50% of cycles last more than a year) and follow a “fast first, slow later” pattern, with central banks more inclined to make cautious, incremental adjustments near the terminal rate.

Second, rising unemployment and a policy rate that is high relative to the neutral rate are important factors affecting how long a rate-cutting cycle continues.Since rate cuts began, each 1 pp rise in the unemployment rate increases the probability of continued cuts by 40 pp, while each 1 pp overshoot in the policy rate adds 25 pp to the likelihood of continued cuts. By contrast, changes in core inflation and GDP growth have a significantly weaker effect on rate-cut decisions.

Third, In historical soft-landing episodes, central banks typically cut policy rates below neutral.At the end of a rate-cutting 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 the unemployment rate raises the probability of cutting below neutral by more than 20 percentage points, while GDP growth and inflation have limited predictive power for whether a rate-cutting 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 trades (36 key charts)

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

1) 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 good for emerging markets, but the question is how much more room they have to cut

4) Meanwhile, the dollar's trajectory is also crucial...

5) ...this is not just a view focused on emerging markets

6) Uncertainty over tariff policy still needs to be resolved... structural headwinds facing China remain.

7) U.S. small-cap stocks have already been through a recession…

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

9) In 6, small caps rose relative to large caps after two and a half years of underperformance

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

11) Besides cheap valuations, rate cuts will also be a catalyst for small and mid caps.

12) Even on an equal-weighted basis, stock valuations have failed to provide a buffer for the bond market...

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

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

15) Expectations that consumption will remain resilient in 25 face key risks from trade, immigration policy, fiscal cuts and changes in the labor market...

16) …the U.S. labor market’s “jobs are easy to get” indicator 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 positioning is not limited to institutional investors...

20) ...can cash on the sidelines become the main source of support?

21) At the index level, SX5E (the European STOXX 50 Index) has been consolidating since 3 month... This state may persist for longer...

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

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

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

25) Aside from revisions to earnings expectations and the impact of tariffs, in a soft-landing scenario, cyclical sectors typically rebound around 6-8 months after the Federal Reserve begins cutting rates...

26) Despite the cyclical sectors’ poor performance 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 materialize remains uncertain, while China’s M1 growth is weak.

30) Japan was overweighted in 2022 12, and Wall Street chose to add to positions on pullbacks.

31) The UK market is valued relatively cheaply and may hold up comparatively well 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 favor high-quality technology stocks and avoid unprofitable areas.

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

35) ...Unlike at the start of 2023, when most people viewed a recession as the base case—which instead led to positive surprises—the market consensus now seems overly complacent...

36) ...Some of the tailwinds supporting consumer spending may gradually fade...

2024.12.26

U.S. consumer exposure to imports from China

Since the first round of tariffs imposed by the Trump administration, the share of U.S. goods imports from China has fallen from its peak of 18% to 11% today. Although the total has declined, the United States still relies heavily 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 goods spending. Of this, about 80% consists of direct imports of consumer goods, while the remaining 20% consists of intermediate goods and raw materials.

In addition, although China’s imports make a smaller contribution in the services sector, when goods and services are combined, China’s imports account for approximately 1.4% of core U.S. consumer spending.

I.The United States is particularly dependent on imports in certain product categories

The chart above shows that imports from China account for more than 80% of total U.S. imports in household goods such as appliances, furniture and footwear, while China’s share of global exports in these categories also exceeds 60%, far surpassing other countries. In the short term, this heavy dependence is difficult to replace with other exporting countries, as alternative suppliers may lack sufficient capacity.

Second, Producer value perspective

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

If tariffs are fully passed on to consumers, prices of Chinese goods could rise by 2%-10%, concentrated in categories such as kitchenware, appliances, luggage, entertainment goods, footwear and computer equipment.Even after weighting all sources of production, the overall increase in U.S. consumer prices is still between 1%-2%。

This also means Tariffs themselves have a relatively limited effect on U.S. core PCE prices According to GS’s forecast, higher tariffs on imports from China will raise core PCE prices by about 0.24%; including auto tariffs, the overall increase in core PCE prices would be around 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. equity market is now clearly oversold, laying the groundwork for a potential rebound. Historically, the odds of a year-end rally are 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 had largely delivered on its promises; what truly spooked the market was the dot plot for the coming years that was released afterward.In retrospect, this market move may actually have another explanation.

Before Wednesday, U.S. equities had been caught in an extremely severe, highly concentrated trade for several months. Although market performance appeared stable, as mentioned in notes some time ago, The U.S. equity market is currently in a portfolio rebalancing period.

The past two weeks were the time when all domestic mutual funds rebalance their portfolios and make annual allocations, so given that this negative market bias had already been in place, Wednesday’s market may have needed only a catalyst for sellers who needed to reduce positions to start selling.

The reason for discussing this possibility is that, looking back today, Last week’s selling actually occurred across all asset classes: assets with gains were sold, and all assets with losses were sold as well。The key issue is this: if the market was really trading the Fed’s revised dot plot and expecting more persistent inflation, 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 did not happen: assets were moving in the same direction. In that case, it is more likely that portfolio rebalancing flows were using this as a pretext.

Bonds were sold, stocks were sold, gold was sold, Bitcoin was sold—everything was sold.All assets with gains were sold to rebalance and make allocations, while all assets with losses were taken off the books.

It is conceivable and to be expected that many investment managers were waiting for the Fed’s action on Wednesday at the time, The market needed only a reason to sell. Everybody was one side of the boat&I needed to clear the deck.

If that is what happened, the market should continue to rebound. Buying for reallocation would provide a foundation for a year-end rally through the end of the year; historically, the year-end rally usually begins 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.

During the rate-cutting cycle, this good-news trade will continue, because a lot of optimism will persist at least in the first half of the year, such as expectations for Fed rate cuts, more favorable tax policies under the new government, and potential support for infrastructure.

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

In addition, date X is most likely to 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 UK, Asia, and Japan—have growth rates close to recessionary levels: they are growing, but only barely. Meanwhile, the U.S. growth rate is 3.2%, leaving nearly all other countries far behind. This is why U.S. equities have attracted substantial inflows.But this anomaly—the difference in economic growth between other countries and the United States—is unsustainable.

Either other countries will step up across the board and start accelerating growth to catch up with the U.S. economy, or U.S. growth will slow to converge with theirs (the more likely scenario), because the 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 large-scale stimulus package or another type of infrastructure spending bill.

See:

1) Notes 24-12-16 U.S. equities 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. equity market, microeconomic performance outweighs macroeconomics:https://www.meridianresearch.app/notes/75a9cbf5-8715-4f56-8722-9ee9c33dc638?ref=769bd1d1-1bdb-461a-89c9-e42c1ff5beebView note

2024.12.23

Monetary easing next year is underpriced

Expectations for monetary policy easing have cooled markedly. Fed funds futures currently price in less than 40bp of rate cuts in 2025, sharply down from expectations of 125bp following the 50bp rate cut in month 9.

A large part of the adjustment is justified, but it has gone too far.

1) The market’s expectations for easing in 2025 have fallen sharply

2) But the inflation rebound component is actually overstated

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

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

Second, the trade war that took place in 2018-2019 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.

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

5) Europe’s recession 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, and manufacturing indicators have fallen further, which could increase the likelihood of an industrial recession in the eurozone.​​

6）Cushion the Hit from Higher US Tariffs？

Overall, the US-Europe divergence is largely priced in, equities and credit are likely to continue delivering positive returns, but given current high valuations, low hedging costs, and the risk of a seasonal downdraft in the new year, it may be appropriate to increase hedge allocations moderately.

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

We continue to expect oil and natural gas to trade in ranges, with diverging trends across metals (iron ore may fall further), while copper and 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 fallout from the post-pandemic wave of low-cost borrowing. According to Moody’s data, over the past 12 months through 10, the default rate in the global leveraged loan market (primarily the 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 issuance during the pandemic-era low-rate environment is now facing a severe test from high-cost pressures. Although the Fed has begun cutting rates, the impact of borrowing-cost pressures on the market cannot be ignored.

This trend may continue into 2025. On 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 low-rated companies were unable to obtain financing in public or private markets and had to restructure their debt, leading to a much higher default rate in the leveraged loan market than in the high-yield bond market.

More concerning, distressed exchanges accounted for more than half of this year’s default events, the highest proportion ever.Although this type of transaction avoids direct bankruptcy, it substantially reduces lender recoveries. Many asset-light companies (such as those in healthcare and software) may have even lower recovery rates in default because they lack sufficient asset backing.

Even so, the high-yield bond market’s spreads remain at historical lows 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 process advances, borrowing costs may ease somewhat, 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 looser loan terms only delay the problem; they do not solve it fundamentally。

2024.12.25

Review of November industrial profit data

The imbalance between weak domestic demand (retail sales month over month -1.1%) and strong production (industrial production month over month +1.0%) remains the main contradiction. Although the previous meeting reaffirmed that “boosting domestic demand” would be the core policy direction in 2025, it may be difficult to reverse the trends of insufficient consumption and pressure on corporate profits in the short term. The market has some expectations for further consumption-supportive measures (such as subsidies, pension and healthcare support), but the scale may be smaller than expected.

Industrial profits in 11 fell 7.3% year over year, a marked narrowing of the decline (9: -27.1%; 10: -10.0%), pointing to signs of improvement in some industries with policy support.Trade-in subsidies have significantly boosted sales and profit growth in equipment upgrades and home appliance sectors, but overall pricing power remains weak.

Weak Spots:

1) The producer goods sector continues to face PPI deflation and insufficient pricing power, amid intense cutthroat competition.

2) SOE profits remain weak (1-11 month year over year, -8.4%oya), in contrast with the relatively stable performance of private enterprises (-1.0%oya) and foreign-invested enterprises (-0.8%oya).

Our thoughts (some of our views on the mainland will be written in English from now on!! Thank you for your understanding):

1）Consumer sectors, especially home appliances and high-end equipment, continue to benefit from targeted policies, offering selective opportunities.

3) Producer goods sectors face structural challenges; recovery in pricing power and PPI improvement will be key variables.

3）In terms of ownership, focus on private enterprises with stronger adaptability and less exposure to SOE inefficiencies.

2024.12.27

Bank of Japan’s December meeting: Divergence

The BoJ’s December minutes show that the degree of disagreement in the policy decision-making process may have been much more pronounced than the vote indicated.

Although most members supported maintaining the status quo, several also advocated an earlier rate hike.For example, “Japan’s economy is already in a position to adjust the degree of monetary easing,” “the central bank should ease up slightly on the monetary easing pedal,” and “it is necessary to adjust the degree of monetary easing preemptively,” among other views.

These views indicate that, although only Tamura opposed the decision in the vote, the actual divergence was more complex.

The rationale for the policy decision was broadly consistent with the content of Kuroda’s press conference, emphasizing wage trends and uncertainty related to the new U.S. administration.However, judging from the main opinions, the latter had a greater influence on the decision.。

On wage trends, cautious views were not the mainstream; some members were optimistic about wage growth, saying, for example, “The likelihood of substantial wage growth next year is high” and “We expect wage growth in line with 2% price increases in next spring’s labor-management negotiations.” This indicates that members had limited concerns about wage growth.

At the same time, several members pointed to uncertainty about the U.S. economy from different perspectives and said that “economic developments need to be watched closely.” Overall, There was little consensus among members on the need to act hastily, partly because the yen exchange rate was not creating pressure and inflation had not accelerated significantly over the past few months.

But It is worth noting that the BoJ’s assessment of uncertainty related to the U.S. economy has changed.From the summer through the October meeting, the U.S.economic uncertainty was primarily viewed as a downside risk; this time, however, the focus shifted to uncertainty about the new administration’s policies and emphasized that “the U.S. economy may accelerate again due to factors such as the new administration’s fiscal policies, rather than experience a soft landing,” even noting that “the balance of risks has shifted more to the upside.” Although a shift in the balance of risks would usually provide a rationale for raising rates, the actual decision went in the opposite direction. Clearly, the committee was more inclined to wait amid uncertainty.

The BoJ’s conditions for a rate hike: assessing wage trends and uncertainty surrounding the new U.S. administration—unlikely to become clear in the short term (such as before the January meeting).Therefore, since the rate hike was postponed in December, explaining a hike at the January meeting will be more challenging. However, judging from this meeting’s main opinions, several members already supported an early hike, so the decision to wait may be viewed as merely the lower-risk choice.

Against this backdrop, since the December decision, the dollar/yen (USD/JPY) has begun an upward trend, while the timing of Trump's imminent inauguration is also close to the BoJ's January meeting. These factors may change some members' perception of the urgency. Although uncertainty will persist until the last moment, But we still think the BoJ is highly likely to raise rates in January.

2024.12.27

Note: All content in this article 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 decision-making.