On Wednesday, March 18th (local time), the U.S. Federal Reserve concluded its two-day monetary policy meeting by announcing a reduction in the federal funds rate target range to 4.75% to 5.0%, marking a 50-basis-point cut. This is the first interest rate decrease by the Federal Reserve since 2020.

  Why did the Federal Reserve decide to cut interest rates by 50 basis points?  

Analysis suggests that historically, unless confronted with a major economic crisis, the Federal Reserve rarely initiates a new rate-cutting cycle with such a substantial 50-basis-point reduction. The Fed's decision to cut rates more aggressively than market expectations may be an effort to engineer a "soft landing" for the economy, hedging against the risk of a slowdown in economic activity.

Recent data indicates that the U.S. Consumer Price Index (CPI) in August rose 2.5% year-over-year, reaching its lowest level since February 2021 and nearing the Fed's 2% inflation target. Powell noted that the Personal Consumption Expenditures (PCE) price index has fallen from around 7% to 2.2% in August, signaling a "significant easing" of inflation. The latest economic projections released by the Fed on the day show that the median forecast for the PCE price index at year-end among Fed officials is 2.3%, down from 2.6% in June.

Amid declining inflation, signs of weakness have emerged in the U.S. job market. Powell pointed out that the average monthly job growth over the past three months stood at 116,000, significantly lower than the pace earlier this year. Meanwhile, the unemployment rate has climbed to 4.2%. According to the latest economic projections, the median forecast for the year-end unemployment rate among Fed officials is 4.4%, up from 4.0% in June, indicating less favorable labor market conditions than previously anticipated.

Slowing personal consumption expenditure, persistent contraction in manufacturing activity, and continued softness in the labor market, evidenced by a substantial decline in new jobs added in both the private sector and non-farm payrolls month-over-month, have fueled concerns among some investors that the U.S. economy is nearing a recession.

Furthermore, the economic projections reveal that all 19 members of the Federal Open Market Committee (FOMC) anticipate additional rate cuts by year-end, with 9 expecting a cut of 50 basis points and 7 forecasting a cut of 25 basis points.

   How does the interest rate cut affect trade?   

Exchange rate fluctuations:

From 1982 to 2019, the United States initiated interest rate cuts on seven occasions. Historical data suggests that during U.S. dollar easing cycles, there is a higher probability of the Chinese yuan appreciating against the U.S. dollar. Following this recent Federal Reserve rate cut, it is anticipated that the Chinese yuan may appreciate against the U.S. dollar.

In the broader context of monetary policy, the direct impact on foreign trade is relatively limited. While Federal Reserve interest rate hikes are likely to influence exchange rates, currency fluctuations are an inherent part of the market, and many foreign trade enterprises are well-versed in managing currency risks, thus alleviating significant concerns.

In the foreign exchange market, a decrease in the Renminbi (RMB) exchange rate, or appreciation of the RMB, benefits China's import-oriented economy but can be detrimental to exports.

Capital inflow:

Following the Federal Reserve's interest rate cut, the attractiveness of dollar-denominated assets relatively diminishes, prompting global capital to seek out higher-yielding investment opportunities. As the world's second-largest economy, China naturally emerges as one of the prime destinations for this capital flow, a development that bodes well for the domestic economy and fosters growth. A thriving domestic economy inherently supports the development of the country's foreign trade supply chains, thereby benefiting the export sector positively.

Trade friction:

If interest rate cuts lead to the depreciation of the US dollar, it will inevitably exacerbate trade frictions between the United States and other countries, and other countries may believe that the United States is enhancing its export advantage through currency depreciation.

The depreciation of the US dollar may also trigger retaliatory measures from other countries, such as raising tariffs or implementing other trade barriers, further exacerbating global trade tensions.

  How can those in international trade respond?  

The Federal Reserve's 50-basis-point interest rate cut, marking the first reduction of this magnitude in four years, prompts those in international trade to pay close attention to exchange rate fluctuations, as these directly impact the cost, pricing, and market competitiveness of exported goods.

Amidst the evolving global economic landscape, particularly adjustments in the monetary policies of major economies, several strategies can be adopted:

Firstly, the use of financial derivatives such as forward contracts, options, and swaps can help lock in exchange rates, thereby reducing the uncertainty that currency fluctuations impose on export operations. Secondly, optimizing currency portfolios by reducing reliance on a single currency and diversifying into a mix of currencies can mitigate exchange rate risks. Furthermore, enhancing financial management and cost control, alongside boosting the value-added and competitiveness of export products, can equip businesses to better tackle challenges arising from exchange rate changes.

In summary, traders must closely monitor the Fed's monetary policy moves and global trade dynamics, ready to promptly adjust strategies to address potential risks and seize emerging opportunities.