United States: Fed turns surprisingly dovish, hints at September rate cut restart, USD liquidity may move toward stage-wise easing.
At last Friday's global central bank annual meeting, Fed Chairman Powell unexpectedly turned dovish, proposing the need to adjust monetary policy to balance risks. This statement suggests the Fed may restart rate cuts at the September FOMC meeting, with markets pricing in a 86% probability of a September rate cut.
Chart 1: Futures market expects September Fed rate cut probability to rise to 86%
Source: Bloomberg, CICC Research Department
Powell's pivot indicates the Fed has chosen "stable growth" over "inflation control" in the dilemma between the two, which can reduce US recession risk but increase stagflation risk. We expect US inflation has reached an upward turning point, with the upward cycle lasting nearly one year.
Chart 2: Inflation component model predicts US inflation may continue rising over the next year
Source: Haver, CICC Research Department
However, in the next 1-3 months, we believe investors will find it difficult to reach conclusions about the duration and magnitude of inflation's upward trajectory. The Fed can also completely interpret rising inflation as a "temporary" phenomenon. It may not be until late 2025 or early 2026 that persistent inflation rises challenge the "temporary inflation theory" and hinder the Fed's pace and magnitude of rate cuts. Therefore, the upcoming period may become a stage-wise USD easing cycle. When the Fed cuts rates amid "rising inflation + declining growth," historical experience shows USD depreciation, gold appreciation, falling US bond yields, but mixed US equity performance.
Chart 3: When the Fed cuts rates amid "rising inflation + declining growth," historical experience shows USD depreciation, falling US bond yields, gold appreciation, but mixed US equity performance
Source: Bloomberg, iFinD, CICC Research Department
Note: Rising inflation refers to periods when core CPI year-over-year growth rate's 6-month moving average is rising, declining growth refers to periods when GDP year-over-year growth rate's 6-month moving average is falling. The intersection of rising inflation, declining growth, and Fed rate cut periods is used to calculate asset returns.
In this Fed easing cycle, inflation prospects are the biggest variable, but may have limited impact on restraining the USD downward cycle: If inflation pressure is lower than we expect, fundamentals support continued Fed easing, driving USD decline. If US inflation rebounds and the Fed persists with rate cuts under political pressure, this may damage Fed independence and USD credibility, equally supporting USD decline. USD decline reflects USD liquidity easing, supporting both domestic and foreign asset classes, particularly benefiting non-US equities and gold performance.
Chart 4: During USD decline periods, gold, commodities, and equities tend to rise, with non-US equities outperforming US equities
Source: Haver, CICC Research Department
Investors were once concerned about Q3 US debt issuance pressure this year. We believe this deserves attention but may not be the market's main contradiction, with limited impact on USD liquidity: Due to tariff revenue improving fiscal conditions, the US fiscal deficit ratio is declining, reducing the necessity for accelerated debt issuance.
Chart 5: Due to tariff revenue improving fiscal conditions, the US fiscal deficit ratio is declining, reducing the necessity for accelerated debt issuance
Source: Haver, CICC Research Department
The debt ceiling was resolved early in July, so Treasury funding replenishment needs were originally smaller than during previous debt ceiling periods, and the Treasury can gradually issue bonds to fill funding gaps, alleviating market pressure.
Chart 6: The debt ceiling issue was resolved early in July, with US TGA account balances higher than previous debt ceiling levels, reducing the amount needed for debt issuance to replenish funds
Source: Bloomberg, CICC Research Department
More importantly, US market liquidity remains abundant, with bank reserve levels far above 2019 "money shortage" levels, and the Fed can use SRF, SLR and other liquidity tools to supplement liquidity in a timely manner.
Chart 7: US market liquidity is abundant, with bank reserve levels far above 2019 "money shortage" levels, reducing liquidity risk
Source: Haver, CICC Research Department
Therefore, we believe US debt issuance risk is relatively controllable, with overseas macro risks mainly stemming from economic fundamentals and Fed policy. Since the Fed has clearly stated its position, downplaying inflation risks and opening a rate cut cycle, USD liquidity may improve stage-wise, boosting risk appetite.
China: Fiscal front-loading, macro liquidity flowing into equity market liquidity.
After "924" last year, government leveraging and fiscal stimulus injected money, with both M1 and M2 turning upward. Combined with low base effects from clearing manual interest subsidies in the same period last year, M1 growth rebounded rapidly from -3% lows to 5.6%. Macro liquidity continues to improve.
Chart 8: China's M2 has grown significantly in recent years, with fiscal stimulus contributing substantially
Source: Wind, CICC Banking Team
Chart 9: M1 and M2 growth rates turn upward, M2-M1 scissors gap narrows
Source: Wind, CICC Research Department
Since "924," policy implementation has not only boosted macro liquidity but more importantly effectively reversed pessimistic expectations, forming policy put options that reduce equity market downside risk. During Spring Festival, DeepSeek emerged, while innovative pharmaceuticals, defense and other emerging industries subsequently welcomed their "DeepSeek moments," opening market upside space. After "reciprocal tariffs" were announced in April, Chinese equities showed resilience, followed by three rounds of China-US trade negotiations reducing bilateral tariff levels, with some US tariffs on China postponed, greatly reducing external uncertainties. Combined internal and external factors significantly elevated Chinese equity expected returns.
Chart 10: Among household financial assets, equity market returns significantly improved
Source: Wind, CICC Research Department
Household wealth needs asset allocation among property, equity, bond markets and deposits. While equity allocation cost-effectiveness rises, low interest rate environments weaken bond and deposit attractiveness, and the second half of financial and credit cycles weakens property attractiveness. Asset allocation demand leads to "deposit migration" into equity markets, converting macro liquidity into equity market liquidity. July financial data shows non-bank deposits increased by 2.1 trillion yuan, historically second-highest and significantly above seasonal levels.
Meanwhile, A-share daily trading volume and turnover rates substantially increased, with margin balances entering a new expansion round. Capital inflows drive equity market gains, which attract more capital inflows, creating positive feedback between equity performance and capital flows, reinforcing equity upward trends.
Chart 11: A-share daily trading volume and turnover rates substantially increased
Source: Wind, CICC Research Department
Chart 12: A-share margin balances enter new expansion round
Source: Wind, CICC Research Department
Logically, during loose liquidity periods, funds could enter either equity or bond markets. However, under low inflation backgrounds, China's equity-bond correlation may remain negative long-term, making "equity-bond seesaw" more likely than "equity-bond dual bull" markets.
Chart 13: Post-pandemic, China's equity-bond correlation shifted from positive to negative
Source: Wind, CICC Research Department
Chart 14: During low inflation periods, growth expectations dominate market trends, with equity-bond correlations declining and turning negative
Source: Wind, CICC Research Department
China-US liquidity resonance creates market window period, with risks in sustainability and volatility.
Since both US and Chinese liquidity are marginally moving toward easing, and with time still remaining before the next round of China-US negotiations deadline in November, the next 1-2 months may represent a window period for loose liquidity trading, providing relatively favorable macro environments for domestic and foreign equities, gold, US bonds and other asset classes.
Chart 15: Both China and US M2 are rising, liquidity may synchronously ease
Source: Wind, CICC Research Department
However, we must be alert that synchronized internal and external liquidity easing may also be stage-wise, with market sustainability facing variables: Externally, if US inflation continues rising, it may ultimately disrupt Fed rate cuts and USD liquidity easing pace. Internally, this year's fiscal front-loading accelerated government bond issuance pace. Without further stimulus policies, government bond issuance pace may begin slowing, driving M2 and social financing toward downward turning points, tightening macro liquidity.
Chart 16: This year's fiscal front-loading accelerated government bond issuance pace
Source: Wind, CICC Research Department
Additionally, in liquidity-driven markets, equities and other risk assets have already experienced significant gains. Approaching early September important celebrations and concentrated disclosure of domestic and foreign economic data, asset volatility may rise, with current market environments presenting both risks and opportunities.
Asset allocation recommendations: Overweight A-shares, Hong Kong stocks, and gold; standard weight China-US bonds; underweight commodities; upgrade US equities from underweight to standard weight.
China-US liquidity environments improve in resonance, with USD likely declining further, benefiting various asset classes (equities, bonds, gold, commodities). We recommend increasing risk appetite and overweighting Chinese equities.
From valuation perspectives, CSI 300 Index dynamic P/E ratio stands at 14x, approaching historical average (15.5x). During bull market cycles in 2021, 2015, and 2009, CSI 300 P/E ratios reached 17x, 19x, and 32x respectively, indicating Chinese equity valuations still have upward space.
Chart 17: CSI 300 P/E ratio below historical bull market peaks
Source: Wind, CICC Research Department
From potential off-market fund perspectives, private fund position levels remain below historical averages, active equity-oriented public fund A-share positions fell to ten-year lows, and active foreign capital still underweights Chinese equities. Broadly, profit effects and capital inflows may continue forming positive cycles with equity performance. However, given prior substantial gains and economic fundamentals still requiring improvement, early September market short-term volatility may increase.
For US equities, we previously proposed that policy turning points create market inflection points. Since Trump has significantly corrected economic policies and the Fed has clearly turned accommodative, we recommend upgrading US equities from underweight to standard weight. However, not being pessimistic doesn't mean turning optimistic: From valuation perspectives, US equities remain expensive relative to US bonds and non-US markets, with S&P 500 equity risk premium approaching 0%. Meanwhile, US equity volatility is too low, mismatched with interest rate environments, potentially creating latent risks.
Chart 19: US equities remain expensive relative to US bonds and non-US markets
Source: Bloomberg, CICC Research Department
Chart 20: US equity VIX is severely underestimated relative to term spreads
Source: Bloomberg, CICC Research Department
Based on past market performance when the Fed cut rates during stagflation periods, US equities didn't necessarily rise. In historical USD depreciation cycles, US equities often underperformed non-US markets after accounting for USD exchange rate losses, making US equities non-optimal among global equity assets. From early 2025 to present, Shanghai Composite cumulative return reached 16%, exceeding S&P gains of 10%, while Hang Seng Tech returned 30%, significantly above NASDAQ's 11% gain. Considering USD depreciation of 2% against RMB, Chinese equities clearly outperformed US equities, consistent with historical patterns during USD decline periods. Considering comprehensive risk-return profiles, we believe A-shares and Hong Kong stocks offer better allocation cost-effectiveness than US equities.
Liquidity turning accommodative, with declining real interest rates and USD index equally benefiting gold performance. We maintain gold overweight. Gold's rapid early-year gains exceeded levels matching fundamentals, causing increased short-term volatility. From long-term trend perspectives, current gold rally magnitude and duration remain far below previous gold price upward cycles, possibly still in early bull market stages.
Chart 21: Compared to historical gold bull market rally magnitudes and durations, current gold market evolution may remain insufficient, possibly still in early stages of gold bull market
Source: Wind, CICC Research Department
We recommend de-emphasizing gold trading value while focusing on long-term allocation value, adding on dips. Chinese interest rates declined too rapidly relative to economic fundamentals over the past two years. Rising risk appetite and "equity-bond seesaw" effects suppress bond market performance, with interest rate levels possibly converging somewhat toward economic fundamentals.
Chart 22: Bond interest rates declined too rapidly relative to economic fundamentals over the past two years; under "equity-bond seesaw" effects, bond interest rates may relatively converge toward economic fundamentals short-term
Source: Haver, Budget Lab, CICC Research Department
However, against backgrounds of credit cycle and economic growth center downward shifts, long-term declining interest rate centers remain the major trend.
Chart 23: Based on international experience, during credit cycle second halves with private sector deleveraging, interest rates often experience long-term downward cycles
Source: Wind, CICC Research Department
Considering multiple bullish and bearish factors, we recommend standard weight Chinese bonds. Although this year's US debt supply risk is controllable, inflation risks may gradually emerge in 1-2 quarters, increasing market uncertainty. If secondary inflation delays materialization or US economy declines significantly, ten-year US bond yields falling below 4% remains possible. Conversely, inflation rebounds could completely cause the Fed to slow rate cut pace after September cuts, with rates rising again. We maintain neutrality on US bonds, recommending standard weight allocation.