Chinese equities experienced a week of mixed performance, with the benchmark indices showing a downward bias. The central theme dominating market attention remains the Federal Reserve's potential interest rate decision in September.
Data released showed the U.S. core Consumer Price Index rose 0.3% month-over-month in August, surpassing the 0.2% that economists had projected. Following this release, market pricing suggests roughly a 90% probability of a rate hike at the Fed's upcoming meeting. Overnight index swaps indicate that markets have priced in approximately 53 basis points of tightening by year-end, which fully accounts for at least two quarter-point increases.
Although substantial capital expenditure in the AI sector and elevated oil prices stemming from geopolitical tensions are supporting upward pressure on U.S. inflation, the current U.S. economy is exhibiting K-shaped divergence, with the household sector showing signs of weakening. Consumer confidence indicators remain under pressure, with August data sitting at just the 5.04th percentile of the past decade. On the employment front, non-farm payroll additions have only recently turned positive after several months, though the stability of this trend requires continued monitoring.
Given that U.S. policy rates are already at relatively elevated levels, even if the Fed were to implement a precautionary rate hike, the scope for further increases appears limited. The current U.S. economic environment differs significantly from the backdrop of every Fed tightening cycle since 1990. Should the Fed proceed with a precautionary hike in September, the March 1997 and June 1999 rate increases during the "New Economy" era may offer some reference points, though it is important to note that household consumption and employment conditions were notably stronger in those periods than they are today.
The Fed officially characterized both of those historical moves as precautionary in nature. Regarding the 1997 hike, the Fed believed that while inflation remained quite moderate, strong aggregate demand and high resource utilization posed a clear risk of future inflationary pressures, warranting decisive preemptive policy action. Fed Chairman Alan Greenspan later described it as an "insurance-type" hike against potentially adverse outcomes. For the 1999 increase, Greenspan indicated that inflationary pressures were well controlled but that action was needed before economic imbalances genuinely threatened stability. The Fed directly labeled it a "modest precautionary measure" designed to avoid having to take more aggressive, potentially destabilizing actions later.
Looking at the aftermath of the March 1997 hike of 25 basis points, the Asian financial crisis, Russian debt crisis, and LTCM crisis erupted in quick succession. This prompted the Fed to hold rates steady for over a year before initiating a series of three 25-basis-point cuts starting in September 1998. In June 1999, the Fed again raised rates by 25 basis points and commenced a new tightening cycle.
Examining asset performance around these two historical rate hikes provides valuable context. In the six months surrounding the March 1997 increase, U.S. equities trended upward while 10-year Treasury yields traded in a range, reflecting strong economic fundamentals and market confidence in ongoing information technology development. In the shorter term, Treasury yields began rising in December 1996 and stocks started pulling back in January 1997, both anticipating the rate move. Once the hike was delivered, yields essentially peaked and stocks bottomed out, with both trends reversing in late April as yields declined and equities resumed their advance.
For the June 1999 hike, markets traded well ahead of Fed expectations. During the 1998 easing cycle, both Treasury yields and equities bottomed and recovered. Once the Fed shifted to a hold, yields rose steadily while the equity uptrend gradually lost momentum. Interestingly, stocks experienced a brief acceleration around the actual rate hike, possibly reflecting a "buy the news" response. Over the medium term, equity performance was driven by fundamental strength. Despite continued Fed tightening, stocks underwent four months of consolidation before entering a powerful bull phase supported by improving economic conditions, with market peaks aligning closely with fundamental peaks.
Credit spreads had fallen to cyclical lows before both historical hikes and remained subdued for a period afterward. Only when market risks materialized did credit spreads shift higher, stocks decline, and the Fed pivot to easing. Currently, credit spreads continue to trend lower, suggesting strong risk appetite driven by the U.S. technology sector trend, with markets relatively optimistic about corporate earnings, cash flows, and debt servicing capacity.
In the period preceding the 1997 precautionary hike, the U.S. economy was in an expansionary phase powered by the "New Economy." The commercialization of the internet accelerated, with Netscape's 1995 IPO marking a significant milestone, and the 1996 Telecommunications Act further opened communications markets. This drove investment expansion in network infrastructure and information communication equipment. Gold, during this period, was not primarily influenced by the dollar or real yields. European integration and uncertainty surrounding central bank gold reserves led several European central banks to sell gold, causing sustained price declines.
By 1999, gold had been in a downtrend for over three years amid concerns about uncoordinated central bank selling. As markets priced in the Fed's precautionary hike, gold came under additional pressure with a steeper decline trajectory. However, on September 26, 1999, 15 European central banks signed the first Central Bank Gold Agreement, with signatories holding approximately 45% of global gold reserves. Major holders including the U.S., Japan, Australia, the IMF, and the BIS also indicated support or pledged not to sell gold. This triggered a sharp gold price surge, though subsequent consecutive rate hikes in the new cycle renewed downward pressure until the next easing cycle began.
Looking ahead, the Fed may deliver a precautionary hike in September, but the scope for further tightening appears constrained. With markets already pricing in roughly two rate increases this year, A-shares are likely to remain rangebound in the near term. However, we recommend positioning on dips and awaiting the actual decision, as its implementation may be interpreted as a clearing of negative overhang. Over the medium term, earnings growth for both the STAR 50 and CSI 300 indices is expected to reach new highs in the fourth quarter. Driven by earnings momentum, A-shares should trend upward in the second half from an absolute return perspective, presenting opportunities across market segments. Structurally, the earnings growth differential between STAR 50 and CSI 300 is poised to set new records in Q4, suggesting that growth and technology styles may again outperform this year. That said, after the sharp pullback following extreme style divergence in mid-year, the next round of style differentiation is likely to be more moderate.
Market review for the week: Trading was mixed across major indices, with the ChiNext gaining 1.08% while the Shanghai Composite fell 1.07%, the Shenzhen Component declined 0.34%, the CSI 300 dropped 0.83%, the STAR 50 lost 1.52%, the CSI 500 fell 0.94%, and the CSI 1000 declined 1.08%. Growth style outperformed with a 0.17% gain, while consumer style lagged with a 3.04% decline. By sector, communications, building materials, and conglomerates led with gains of 6.87%, 3.05%, and 2.09% respectively, while non-bank financials, computers, and beauty care underperformed with losses of 4.62%, 4.61%, and 4.61%. Market activity moderated slightly with average daily turnover of 1,892.962 billion yuan, down 76.815 billion from the prior week. The overall P/E ratio for A-shares stood at 21.41 times, down 0.87% week-over-week.
Risk warnings: Domestic policy implementation may fall short of expectations; geopolitical events could exceed projections; overseas liquidity easing may disappoint.