Policy Implications: Inflation Rebound May Constrain Fed Rate Cuts, Monetary Policy Uncertainty Rises

The US July employment data fell significantly below market expectations, with substantial downward revisions to May-June figures (also affected by flaws in seasonal adjustment models). This led markets to anticipate Fed rate cuts starting September, initially pricing in three cuts this year. The rate-cut expectations drove a rebound in US stocks despite the weak jobs report.

However, based on our analysis that US inflation may soon reach an upward inflection point, we believe the Fed's rate-cut path remains highly uncertain:

• If economic growth slows sharply or enters recession, the Fed could cut rates aggressively.

• But if growth stagnates while inflation rises (stagflation), the Fed may face a dilemma, potentially unable to sustain rapid rate cuts.

We cannot yet determine whether the US economy will tilt toward recession or stagflation, keeping 2025 rate-cut expectations volatile. Since tariff-driven inflation is concentrated in the next ~12 months, we see rising likelihood of substantial Fed rate cuts in 2026.

Asset Implications: Inflation May Disrupt Markets—US Stocks/Bonds Under Pressure, Dollar Short-Term Boost but Medium-Term Risks Rise, Gold & China Assets Show Resilience

If our inflation model proves correct, a rapid US inflation rebound could disrupt Fed easing expectations, negatively impacting most assets (stocks, bonds, commodities). US equities and Treasuries would be most vulnerable. Given elevated US stock valuations and their sensitivity to both stagflation/recession, we recommend underweighting US equities. While inflation is near-term bearish for Treasuries, growth slowdown/recession risks are bullish. With manageable US debt issuance, Treasuries may offer better risk-reward than stocks—though near-term volatility could rise. A inflation-driven delay in rate cuts may briefly support the dollar, but with "American exceptionalism" fading and the greenback in a long-term downtrend, we cannot rule out a "triple whammy" (stocks-bonds-dollar selloff), warranting caution on USD.

Dollar and Treasury yield moves may spill over to non-US assets, but market swings also create buying opportunities. We highlight gold and China assets as relatively resilient:

• Gold benefits from stagflation/recession risks and 2026 monetary/fiscal easing.

• China assets have entered a revaluation phase post the 9.24 policy shift and DeepSeek's emergence. Reshaping global monetary order, capital reallocation, and ample domestic liquidity further support Chinese assets. After mid-late August macro risks subside, we expect Chinese equities—especially tech/growth stocks representing new productive forces—to show stronger allocation value.