European Stocks Plunge; Market Bets on Fed Rate Cut This Week

• News
• 2024-11-18

Continuing the downward trend in the Asia-Pacific stock market, major European stock indices opened sharply lower.

As of 3:00 PM Beijing time on the 5th, the Euro Stoxx 50 index fell by 2.94%, the German DAX index fell by more than 3%, the UK's FTSE 100 index fell by 1.77%, the French CAC 40 index fell by 1.29%, and the Italian FTSE MIB index fell by more than 4%; the Portuguese stock index PSI fell by more than 2%. The Euro Stoxx 600 Technology Index fell by 5.1% to its lowest point since January of this year.

In the earlier Asia-Pacific trading session, both the South Korean Composite Index and the Kosdaq Index triggered circuit breakers, while the Nikkei 225 index closed down 12.4%, marking the largest single-day percentage drop in history. The Nikkei 225 Volatility Index surged by 132%, setting the largest single-day increase since 1990. Nikkei 225 Volatility futures were suspended for the second time in this trading session due to the trigger of the circuit breaker mechanism.

Currently, the U.S. bond market has begun to bet on the Federal Reserve unexpectedly lowering interest rates ahead of schedule. Bond traders estimate that there is a 60% chance the Federal Reserve will cut rates by 25 basis points within the next week.

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This expectation is driving the U.S. bond market to record the largest rebound since the banking crisis erupted in March 2023. The two-year U.S. Treasury yield, which is most sensitive to interest rates, plummeted by 0.5 percentage points last week, falling below 3.9%. Meanwhile, the federal benchmark interest rate is currently around 5.3%, making the two-year U.S. Treasury yield lower than the federal benchmark interest rate by the largest margin since the global financial crisis. U.S. bonds continued their upward trend today, pushing the 10-year U.S. Treasury yield to 3.7%.

Not only the Federal Reserve, but the market has also increased its expectations that the European Central Bank will follow the Federal Reserve's lead and cut interest rates by a larger margin. Traders are now betting on a 60% chance that the European Central Bank will cut rates by 50 basis points in September. As a result, the yield on 10-year German government bonds has fallen to its lowest level in seven months.

Tracy Chen, portfolio manager at Brandywine Global Investment Management, said: "The market is concerned that the Federal Reserve is lagging behind the yield curve, and the outlook is shifting from a soft landing to a hard landing. U.S. Treasuries are a good choice in this situation, and I do believe that the economy will continue to slow down."

In fact, before encountering "Black Friday" (August 2nd) and "Black Monday" (August 5th), the Federal Reserve remained inactive last week, hinting that a rate cut in September has already made the market lose patience. On the 5th, Jan Hatzius, Chief Economist at Goldman Sachs, raised the probability of the U.S. falling into a recession within the next year from 15% to 25% in his latest research report. "Stock God" Warren Buffett's significant selling in the second quarter also intensified market concerns. Cathy Seifert, an analyst at U.S. investment bank CFRA Research, commented that Buffett's substantial selling may be due to recession concerns, as Berkshire Hathaway has always been "preparing for a weak economic environment."

The Federal Reserve stated last Wednesday that it did indeed notice progress in inflation, but also reiterated that the policymakers of the Federal Open Market Committee (FOMC), which sets interest rates, need "greater confidence" that inflation is returning to 2% before they can prepare to cut rates.

However, Jeffrey Gundlach, CEO of DoubleLine Capital, believes that the Federal Reserve's stance on interest rates risks falling into a recession. He said in an interview with the media last Wednesday, "I've been 'playing' in this market for over 40 years, and this kind of situation (late rate cuts leading to economic recession) happens almost every time. Currently, employment data and some other potential economic indicators are not improving, but rather deteriorating.""This means that the Federal Reserve will subsequently have to cut interest rates, and the magnitude of the cuts may be greater than what they currently have planned," he said. He anticipates that the Federal Reserve may ultimately cut rates by 1.5 percentage points next year, which is more aggressive than the Federal Reserve's "dot plot." "If there is to be a positive real interest rate, it means that the Federal Reserve has room to cut rates by 150 basis points, and this magnitude is not too large either," he stated. "Frankly, I believe they should have started cutting rates in July."

Goldman Sachs expects the Federal Reserve to cut rates by 25 basis points each in September, November, and December. Furthermore, Goldman Sachs indicated that if the forecast is incorrect and the August non-farm employment data is as weak as in July, there is a high likelihood of a one-time rate cut of 50 basis points in September. JPMorgan Chase and Citigroup have already directly raised their expectations, predicting that the Federal Reserve will cut rates by 50 basis points in September. Since the pandemic or credit crisis, the Federal Reserve has never made such a significant rate cut.

Kevin Flanagan, Head of Fixed Income Strategy at asset management firm Wisdom Tree, said: "As we saw at the end of last year, the market sometimes overshoots the Federal Reserve's policy expectations, leading to an overshoot in market trends. Subsequently, we still need to verify the path of rate cuts from more data."