Why 2025 Fed Rate Cuts May Not Boost China Markets

The Federal Reserve is anticipated to implement three rate cuts in 2025, as market expectations for easing monetary policy intensify, with the probability of a September rate cut standing at 92% based on CME interest rate futures data [1]. This expectation is driven by growing pressure on traditional sectors of the U.S. economy, including manufacturing and real estate, which are being strained by persistently high interest rates. The ISM Manufacturing PMI has declined from 50.9 in January 2025 to 48 in July, nearing levels that historically signal the need for rate cuts [2]. Similarly, real estate demand remains weak, with existing home sales approaching the 3.9 million unit low seen in September 2024, while new home sales have shown a continuous year-on-year slowdown [3].

A key concern among investors is the potential impact of these rate cuts on the Chinese market. While many assume that lower U.S. rates would lead to capital inflows into emerging markets like China, historical data suggests this outcome is not guaranteed. The transmission mechanism often cited—Federal Reserve rate cuts leading to a weaker U.S. dollar and U.S. Treasury yields—is not universally valid, particularly in "preemptive" rate cut cycles where the economy is not in outright recession [4]. For instance, in the 2024 rate cut cycle, U.S. Treasury yields and the U.S. dollar index hit their lowest points in September and then rebounded, contradicting the assumption that rate cuts always weaken the U.S. dollar [5]. Similar patterns were observed in 2019 and 1995, reinforcing the idea that the economic context and type of rate cut significantly influence market outcomes [6].

The U.S. economy currently faces a mismatch between real interest rates and natural rates, with the former at 1.87%, significantly higher than the latter at 1% [7]. Additionally, in the real estate sector, mortgage rates remain above rental yields, and in the corporate sector, commercial loan rates exceed return on invested capital (ROIC), signaling inefficiencies in capital allocation [8]. These imbalances underscore the need for rate cuts to stimulate demand and restore economic equilibrium. However, the anticipated short-term relief from rate cuts may be limited, as the underlying macroeconomic structure suggests that once rate cuts are enacted, U.S. Treasury yields and the dollar could stabilize or even rebound, especially if the economic response is positive [9].

For the Chinese market, while short-term liquidity and sentiment improvements are possible, they may not be sustained. Historical experience indicates that foreign capital inflows have not significantly increased during U.S. rate cut cycles, and domestic fundamentals in China have a stronger influence on market performance [10]. To maximize the benefits of the Federal Reserve’s rate cuts, Chinese policymakers could leverage the favorable external environment to implement more aggressive monetary and fiscal easing in key sectors such as infrastructure and technology [11]. Additionally, structural opportunities exist in export sectors linked to U.S. demand, particularly in real estate-related industries and commodities like non-ferrous metals, which could benefit from improved U.S. economic conditions [12].

The potential appointment of a new Federal Reserve Chair in 2026 introduces an element of uncertainty. If rate cuts exceed expectations, particularly in response to political pressures, U.S. Treasury yields and the dollar could face downward pressure. However, this would not fundamentally alter the core economic logic driving interest rates and exchange rates, but rather amplify short-term volatility [13]. Ultimately, while the Federal Reserve’s rate cuts could provide some short-term support to the Chinese market, the long-term trajectory is more closely tied to domestic policy actions and economic performance.

Source: [1] Is the Federal Reserve's interest rate cut bullish or bearish... (https://news.futunn.com/en/post/60721809/institutions-is-the-federal-reserve-s-interest-rate-cut-bullish)