I. Global Financial Market Volatility and the "Samuelson Principle"

In early August, significant fluctuations in the global financial market sparked widespread discussion. However, when viewed from a longer-term perspective, the actual impact of this volatility on the global economy is quite limited. The U.S. market has gradually recovered, and the Japanese stock market has also rebounded. Therefore, after this fluctuation, with the release of various economic indicators and the adjustment of policy expectations, the global market did not generate panic.

There are several reasons for this: First, the unwinding of the yen carry trade this time is an isolated event. If the unwinding of the carry trade does not overlap with a financial or economic crisis in a certain country, global financial turmoil will not occur. This experience has been verified historically. Second, the main reason for the significant fluctuations in the U.S. market at the beginning of August was the non-farm data and unemployment rate data. In July, the U.S. non-farm data plummeted from 200,000 to 110,000, and the unemployment rate rose to 4.3%, triggering the "Samuelson Principle," causing the financial market to weaken. However, historical patterns do not necessarily apply to today. In recent years, the employment issues in the United States have been largely influenced by illegal immigration, supply-side factors after the pandemic, and the labor participation rate, making the "Samuelson Principle" not necessarily applicable. The proponent of the "Samuelson Principle," Federal Reserve economist Samuel himself, also believes that the market has over-interpreted the "Samuelson Principle" this time. The triggering of the "Samuelson Principle" is likely a "false positive," with the main evidence reflected in the rise of the labor participation rate.

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In recent years, interpreting U.S. employment data has become increasingly difficult. The "Samuelson Principle" should not be used to explain the current problems faced by the U.S. economy. Historically, the "Samuelson Principle" was very effective in 1990, 2001, and 2008, but the specific circumstances of the above three times are different from this time. For example, the average values of U.S. non-farm employment data, U.S. household income, and U.S. industrial production data were all below 0 in the four months before the occurrence of the above three economic or financial crises, but this year these three data are above 0.

II. Stable Economic Operation of the U.S. and Japan

(1) The possibility of the U.S. economy falling into a recession is small

Before and after this turmoil, the data released by the United States shows that the U.S. economy is operating relatively smoothly. The PMI of the U.S. service industry is 51.4%, higher than expected, and has returned to above the 50% boom-or-bust line. The U.S. retail data performance is also good. The number of initial unemployment claims in the United States has declined in the past few weeks. Based on the above data, the U.S. economy does not show the situation of entering a recession as indicated by the historical "Samuelson Principle."

The reasons for this phenomenon are relatively complex. One reason is the high proportion of U.S. public fiscal expenditure. This is significantly different from before the pandemic. The U.S. fiscal deficit as a percentage of GDP is currently between 5% and 6%, and its support for the U.S. economy is very significant. Although the U.S. government has the issue of abusing sovereign currency, in the short term, a high fiscal deficit has a certain supporting effect on the current economy.

The overall judgment of U.S. economists at present is that the possibility of a recession in the United States is very low. We expect that the U.S. GDP growth in the third and fourth quarters of this year will be maintained at around 1.4% and 1.8%, respectively, and it will be able to rebound to 2% next year. We forecast that this year's GDP will reach 2.5%, and next year it will be 2.1%. We predict that the process of U.S. interest rate cuts will not be too aggressive, with the basic process being a 25 basis point cut in September, another 25 basis point cut in November and December, totaling 75 basis points this year; next year, another one percentage point will be cut, totaling 1.75 percentage points by the end of next year. There is a view in the market that the United States will cut by 50 basis points for the first time and 50 basis points for the second time. I personally believe that this situation will not happen because such a method of interest rate cuts would increase panic in the market, and the basic data of the U.S. economy does not support such a process of interest rate cuts.

(2) Positive economic expectations for JapanOn the Japanese front, the significant turning point that triggered the large-scale reversal of the yen carry trade was July 31st. The Bank of Japan announced an interest rate hike of 15 basis points on that day, which exceeded expectations. Only about 30% of people anticipated this move, and combined with the subsequently released U.S. non-farm employment data, the very important events of Japan's rate hike and the U.S. rate cut were interpreted together. Subsequently, the Deputy Governor of the Bank of Japan clearly stated that they would not allow the rate hike to cause significant turmoil in Japan's financial markets. Based on the Bank of Japan's stance and the reversal of the yen carry trade, the likelihood of significant turmoil occurring in the next six months to a year is relatively small. This yen carry trade reversal is an excellent stress test. This stress test did not cause significant turmoil in the global financial markets.

Recently, Japan's economic data has been performing well, with a GDP growth rate of 3.1% in the second quarter. Analysts believe that the Japanese economy has emerged from a quasi-recessionary situation that began in the third quarter of last year. The Japanese economy is also expected to grow well in the next few quarters. Japan's current potential growth rate is about 0.5%, and we forecast that Japan's GDP growth rate will be 1.4% in the third quarter, 0.6% in the fourth quarter, and around 1% next year. Based on Japan's economic fundamentals, we believe that the Japanese economy will not fall into a negative growth state again before the end of next year.

The first reason is that Japan has emerged from a situation of persistent low inflation and deflation, with appropriate wage increases. The rise in wages and inflation in Japan indicates that the economy has entered a virtuous cycle. The second reason is the recovery of the semiconductor industry and other industries, combined with the positive geopolitical impact on Japan, other fundamental data of Japan, including economic indicators such as wage increases and corporate equipment investment, have risen significantly in the past few quarters. The third reason is that due to the depreciation of the yen and the impact of geopolitics, the number of inbound tourists in Japan has repeatedly set new highs, already exceeding the level before the pandemic. Based on the above reasons, we have made a slight adjustment to our forecast for the Bank of Japan's rate hike: the probability of a rate hike by the end of this year is 60%, and there are two more opportunities for rate hikes next year, with a high probability of reaching 1 percentage point.

III. Our country's response strategy

(1) The overall strategy is to wait and see

First, in terms of response strategy, we should wait and see. After the pandemic, the world faces many issues, and financial markets and policymakers are facing many unknown factors. On the one hand, it is necessary to fully consider various risk factors, including capital markets, foreign exchange markets, and the macroeconomy; on the other hand, actions should be slowed down, as a single fluctuation does not predict the arrival of financial turmoil.

Second, the reversal of the yen carry trade has a relatively small impact on our country's financial markets. Moreover, the main impact of the shock does not come from the fluctuation itself, but from the indirect factors dominated by exports. The main problem of China's economy is the issue of domestic demand. China's exports may face a downturn in the second half of this year, but it is not closely related to the fluctuations caused by this yen carry trade reversal.

(2) The economy faces downward pressure in the second half of the year

The downward pressure on the domestic economy will rise significantly in the second half of this year, and it may even have a certain impact on the global economy and financial markets represented by Europe. First, China's real estate market has not yet bottomed out. The real estate sector contributes about a quarter to China's GDP, and its impact on economic fluctuations may far exceed a quarter, because the real estate industry plays an extremely important role, and it functions by transmitting loose monetary and credit policies through the credit market. In the past few rounds of economic recovery, real estate has been the "engine" and "leader" of each recovery.

Second, the growth rate of consumption in our country has significantly declined. The consumption growth rate in July was only about 2%, and the pressure in the second half of the year will increase. The retaliatory consumption after the pandemic is nearing an end. Moreover, the negative wealth effect caused by the sluggish real estate market and stock market in recent years has had a negative impact on consumption. Against the backdrop of a declining economic growth rate, many industries are facing large-scale salary cuts, which also affect consumption. Third, negative growth in "new three items" investment. In the past two years, large-scale investment in "new three items" represented by photovoltaics and batteries has led to the problem of excess capacity, and prices are plummeting. Investment showed negative growth in the first half of this year, and the negative growth will rise in the second half.(III) Policy Recommendations

In response to the aforementioned issues, the following suggestions are proposed:

1. Maintain the stability of the Renminbi (RMB) and avoid significant fluctuations, especially large-scale devaluations. Over the past period, due to concerns about the domestic economy, some have suggested that the RMB should continue to depreciate. The recent yen carry trade has served as a lesson for us, and we need to prevent large-scale yen carry trades from occurring. If the RMB continues to depreciate and interest rates remain low, it could lead to a larger scale of yen carry trades, thereby impacting the domestic economy. At the same time, China's exports are currently strong and should not be further weakened by significant devaluations that could worsen the international environment. The immediate priority is the stability of the domestic financial and real estate markets, as well as the stability of the RMB.

2. Implement a modest interest rate cut to boost domestic demand, particularly by reducing the interest rates on existing loans. The consecutive interest rate cuts that the United States is about to initiate provide an opportunity for China to lower its interest rates. Given the limited space for maneuver, the reduction in China's interest rates will not be substantial and should primarily focus on reducing the interest rates on existing mortgage loans. The scale of existing housing loans during the period from 2015 to 2022 is approximately 30 trillion yuan, with an estimated mortgage interest rate of around 5.2%, which has been reduced by 73 basis points and is currently estimated to be around 4.5%. This is still about 100 basis points higher than the 3.5% level in the second quarter of 2024.

3. Stabilize domestic demand and the real estate market. China's main issue lies in domestic demand. From a global economic perspective, on one hand, the fluctuations since August have been a source of global instability; on the other hand, the insufficiency of China's domestic demand is also a risk factor for the global economy. From a domestic perspective, given the significant downturn in the real estate market, we should introduce a series of policies to stabilize it, especially focusing on ensuring the delivery of homes. The government should take actions from a structural perspective or by increasing central fiscal expenditure, combining these efforts with structural reforms and increasing spending in areas such as social security and healthcare.