Market rebound driven by rate cut expectations

Last week, the temporary decline in prices in both China and the US brought rate cut trading onto the agenda. Rate cuts serve as a catalyst for oversold rebounds, but they are not the core theme for asset allocation. Looking at the market trends over the past month and week, major asset classes and A-share sectors show a clear divergence between short-term fluctuations and medium-term trends, testing investors' ability to distinguish between a rebound and a reversal.

Commodity trends remain relatively clear, with energy and precious metals forming a resonance across short and long cycles. Brent crude oil saw a significant rise over the past month, continuing its upward momentum in the recent week, with the medium-term bullish logic for commodities remaining intact. Gold and silver accelerated their gains in the recent week, amplifying medium-term returns. LME copper and aluminum maintained a steady strengthening trend, with expectations for industrial metal demand continuing to recover.

Equity markets show the most significant structural divergence. A-share indices like the STAR 50, ChiNext, Beijing Stock Exchange 50, and CSI 300 experienced continuous adjustments over the past month, but saw notable rebounds in the recent week. This trend is more a reflection of oversold recovery, with short-term sentiment improving but not yet reversing the medium-term weak pattern. Hong Kong stocks have shifted, with the Hang Seng Index and Hang Seng Tech Index showing strong monthly performance, but short-term momentum has clearly converged, moving from unilateral upward trends to a phase of oscillation and consolidation. US stocks remain resilient, with moderate monthly gains and further short-term returns.

Fixed-income assets have performed steadily, with rate bonds and credit bonds continuing to deliver small positive returns over both short and long periods, showing limited volatility. They remain a defensive allocation for core holdings.

Inflation trends show divergence

The moderate inflation in the first half of the year was favorable for risk asset allocation, but the latest data has led to greater divergence among investors. The July CPI and PPI both fell, with the central inflation trend weakening temporarily, showing a typical pattern of total convergence and structural differentiation. On a total level, declining energy prices, weak food prices, and high base effects dragged down overall prices. Core inflation has fallen slightly for several consecutive months, indicating that the recovery in domestic demand is relatively moderate.

Structurally, traditional cyclical products are under price pressure, but price resilience is evident in AI-driven high-end manufacturing, summer services, and consumer electronics, with the price trends of old and new industries continuing to diverge. Market views on future inflation are now significantly divided, focusing on three key issues: whether inflation has peaked this year, whether a phased rebound will occur in August-September, and the true strength of core inflation and domestic demand recovery.

Some institutions believe inflation has already peaked and lacks sustained upward momentum, while others see the July decline as a temporary disruption, predicting a V-shaped recovery in the third quarter with a multi-peak pattern for the year. There is also divergence on the main driver of PPI and the effectiveness of domestic demand transmission. The essence of this divergence lies in differing views on cyclical timing and driving factors. Bearish views focus on current total data, weak domestic demand, and sluggish traditional real estate and infrastructure demand, arguing that the scale of new industries cannot offset the downward pressure from the cycle. Bullish views focus on time mismatches and structural increments, emphasizing short-term variables like oil price transmission lags, base effects, and pork price recovery, while recognizing the structural inflation resilience from AI-driven new momentum and service consumption upgrades.

The July CPI and PPI data show that AI-driven structural price increases have moved from theoretical deduction to statistical reality. On a total level, declining international energy prices have suppressed traditional industrial products, limiting the overall upward momentum of PPI. Structurally, AI computing power capital expenditure has formed an important offset: the factory prices for computer, communication, and electronic equipment, as well as electrical machinery, rose 4.4% and 5.7% year-on-year, respectively, contributing 2.1 percentage points to PPI growth. Smart hardware and industrial control equipment prices have recovered, and computing power demand has pushed up semiconductor costs, forming a preliminary top-down industry price transmission chain.

On the CPI side, the trend is moderate, with a year-on-year increase of 0.5%, lacking a basis for broad inflation. A notable change is the end of the long-term deflation in consumer electronics, with prices for computers, tablets, and phones rising significantly, contributing 0.14 percentage points to CPI growth. This is due to global AI investment pushing up storage and computing power chip costs, with companies passing on costs downstream. This round of electronics price increases is driven by a combination of AI incremental demand and semiconductor capacity regulation cycles. However, the price transmission is currently limited to the electronics sector, with limited weight, and is unlikely to spread to food and services. The sustainability of this chain faces two constraints: the release pace of new semiconductor capacity and whether household consumption capacity can absorb the cost increase. If supply and demand become mismatched, price transmission may weaken.

Possibility of rate cuts

Based on the emergence of a temporary peak in overall prices, discussions on rate cut trading have increased. Our conclusion is that the probability of rate cuts in both China and the US is low. The Federal Reserve is unlikely to cut rates, with maintaining the current rate being the most probable scenario. US employment remains resilient, with no urgent conditions for a rate cut. Price trends are volatile, with Middle East geopolitical tensions affecting oil prices and adding upward inflation risk. Fed Chair Walsh hopes to find new indicators to better monitor inflation, but new inflation indicators have not yet been formally implemented, and a single month of data is insufficient to confirm a sustained downward trend in inflation. Meanwhile, AI computing power expansion is driving up capital expenditure, temporarily pushing up prices of related goods and factors, creating phased inflation disturbances. Given multiple uncertainties, the Fed lacks sufficient policy signals to support a rate cut, making its best option to stay on hold.

For the People's Bank of China, the July Politburo meeting set the tone for monetary policy to cooperate with proactive fiscal policy and implement moderately loose monetary policy. However, loose policy does not equate to rate cuts, and the probability of a significant short-term rate cut is low. Internally, bank net interest margins are at low levels, and another rate cut would further squeeze profitability, threatening banking stability and financial security. Externally, a rate cut would widen the China-US interest rate differential, increase volatility in the renminbi exchange rate, and undermine domestic asset revaluation expectations. At the same time, loose funds still struggle to effectively reach the real economy. In an environment of overcapacity, corporate investment willingness depends on demand and profit expectations, and simply lowering the cost of funds is insufficient to drive credit expansion. Given multiple internal and external constraints, price-based rate cut tools are approached with caution, with policy leaning more towards using quantitative tools to maintain liquidity stability.

Core theme for asset allocation

Although the probability of rate cuts is low, many investors still treat them as a core theme for asset allocation amid the market rebound. From our factor observation system, the growth factor is the decisive force for the future. Generally, market capital seeks the most fundamental driving force when pricing. In a multi-factor pricing model, the weights of the four factors are not static but dynamically adjust based on the factor's own deviation (Z-score). During stable periods (Z between -1 and 1), the four factors are in a normal fluctuation range, with relatively balanced pricing weights. During extreme periods (absolute Z greater than 1.5), the market switches to a single main line logic when a factor's Z-score breaks through an extreme threshold (e.g., -1.5). Our latest observations show that the inflation factor is around -1.2, having bottomed out; the credit factor is around -0.5, with minor fluctuations; the liquidity factor is in the range of -0.2 to 0.3, relatively mild; and the growth factor, both in reality and expectations, is heading towards -1.5 or even lower, showing the deepest deviation and steepest downward slope among the four charts.

The more a factor's Z-score deviates from zero (greater extreme), and the steeper its recent change slope (greater marginal impact), the more the system automatically assigns greater strategic weight to that factor. Analyzing this data, the conclusion is that the growth factor, not the inflation or liquidity factor, is the market's decisive force. Since liquidity easing is due to weak growth, traders will not trade based on liquidity easing itself but will focus on the actual state of growth. This is why the growth factor has gained the most pricing power. From this perspective, a systemic reversal in total volume is difficult to achieve, but macro total decline does not mean all industries are contracting simultaneously. We have always adhered to the idea that industry cycles are independent of macro totals. Growth sectors with sustained vitality, supported by their own industry logic, are not suppressed by total factors, and the basis for structural market divergence continues to exist. Broad-based bull markets are unlikely, and traditional industries still face challenges. Sectors with a second ignition need to be found within structural bull markets.

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