CMS: The Federal Reserve begins to consider slowing the pace of interest rate cuts

According to the Zhitong Finance APP, CMS released a research report stating that overall, the Federal Reserve's attitude has slightly turned hawkish: 1) Powell repeatedly emphasized that he will be more cautious in approaching the neutral interest rate to achieve a balance of dual risks, and the recent rebound in various interest rates is a result of enhanced economic expectations rather than being driven by inflation expectations; 2) After the election, uncertainty regarding policies and the economy will be higher, and attention should be paid to more signals that may be released during the December interest rate meeting, at which time fiscal factors may be incorporated into the Federal Reserve's model considerations and reflected in the dot plot and SEP in December.

Looking ahead, the implementation of the Trump tax reform in 2018 drove a strong rebound in the U.S. economy. At that time, Powell, who had already assumed the position of Federal Reserve Chairman, significantly raised interest rates throughout the year until the economic slowdown and a sharp decline in U.S. stocks prompted a shift to a dovish stance. In the Trump 2.0 phase, Powell is likely to still base monetary policy on the impact of policies on the economy, and the combination of "increased tariffs + tax cuts" is likely to lead the Federal Reserve to adjust its rate-cutting pace due to the observation of policy impacts. Coupled with the current resilience in economic and employment data, a gradual rate cut in December or 2025 is highly probable.

On the asset side, the "Trump trade" rebound after the election has triggered a market Risk on. Once the market begins to reflect policy uncertainty and factors such as the Federal Reserve's re-adjustment of rate cuts, there may be a wave of Risk off globally. U.S. Treasury yields may fluctuate downward as they have partially accounted for the impact of a slowdown in rate cuts. The RMB exchange rate may still fluctuate in the range of 7.0-7.3.

Event:

On November 7, 2024, local time, the Federal Reserve held an interest rate meeting, lowering the federal funds target rate range by 25 basis points to 4.50%-4.75%, while maintaining the pace of balance sheet reduction.

The main points of CMS are as follows:

The Federal Reserve lowered rates by 25 basis points as expected, abandoning forward guidance and dynamic decision-making.

The Federal Reserve lowered the federal funds target rate range by 25 basis points to 4.50%-4.75%, while maintaining the pace of balance sheet reduction, which involves reducing U.S. Treasury securities by $25 billion per month and MBS by $35 billion per month. Compared to September, there are two changes in the wording of this FOMC statement: First, the certainty of declining inflation has been somewhat moderated, removing the term "further" from the statement about inflation making "further progress" toward the 2% target. In response to a reporter's question, Powell stated that this was to avoid providing forward guidance, expressing "increased confidence in inflation continuing to move toward 2%" and judging that "the dual risks are roughly balanced"; second, the phrase "slowing employment growth" was removed and replaced with "the labor market conditions have generally eased since the beginning of the year."

Signals from Powell's speech and Q&A: Cautiously approaching the neutral interest rate, future decisions may incorporate fiscal policy factors.

1. Economy: Extremely resilient. The actual GDP growth rate for Q3 this year was 2.8% on a year-over-year basis, close to the Q2 growth rate; consumption remains resilient, with investment in equipment and intangible assets strengthening, while real estate performance is weak; overall, improved supply conditions have supported the strong performance of the U.S. economy over the past year. Powell believes that the recent rebound in various U.S. interest rate indicators reflects more the enhancement of economic growth expectations, perhaps accompanied by a reduction in downside risks, rather than being primarily driven by rising inflation expectations

2. Employment: Healthy but with concerns or risks. The unemployment rate has shown a downward trend over the past three months; without the impact of strikes and hurricanes, the non-farm payrolls in October could have been higher; the matching of job vacancies and the labor force has improved; there is no desire for the labor market to weaken further from its current state.

3. Inflation: The decline in inflation may be a long-term process. Inflation has approached the 2% target, but core inflation levels remain slightly above this target; the inflation performance in September was not bad, but only slightly above expectations; low inflation also carries risks, and there are no plans to target inflation below 2%; housing and insurance inflation remain high, but the inflation rate reflected in newly signed leases is extremely low, which will alleviate housing inflation pressure in the long term; inflation is expected to gradually decline to 2% along a winding path over the next few years.

4. Interest Rate Path: Refusal to provide forward guidance, decision-making becomes more cautious as it approaches neutral interest rates. The Federal Reserve has no preset path and will continue to make decisions at each meeting; there is no desire to provide excessive forward guidance; no decision has been made regarding policy actions for December; the pace and targets of monetary policy may change; interest rate hikes are not part of the Federal Reserve's plan; recent economic data has not shown a necessity to rush to bring rates down to neutral levels; caution will be exercised in moving towards a neutral stance to increase the probability of success.

5. Fiscal Policy and Election Factors: The impact path still needs to be observed after policy advancement on the economy. Currently, the Federal Reserve has not modeled potential changes in fiscal policy; once new tax policies are legislated, they will be incorporated into the Federal Reserve's economic forecasting model; in the short term, the election will not have any impact on policy decisions; U.S. fiscal policy is on an unsustainable path; while the debt level relative to the economy is not unsustainable, its trajectory is unsustainable.

How to view the subsequent pace of Federal Reserve policy? Rate cuts are likely to slow down.

At this meeting, Powell strongly maintained a neutral stance, refusing forward guidance, relying on data, and not commenting too much on election results and fiscal policy. Subsequent policies may see three important changes: First, the era of forward guidance is coming to an end. On one hand, the government is unwilling to be "arbitraged" by the market, and on the other hand, uncertainty regarding policies and the economy will be higher after the election, making forward guidance a more risk-neutral choice; Second, the threshold for approaching neutral interest rates may be raised. Powell repeatedly emphasized that caution will be exercised in moving towards neutral interest rates to achieve a dual risk balance, which also means that the threshold for subsequent rate cuts may be raised, akin to Powell's metaphor that "as we approach our established goals, we will gradually slow down our operational pace like a plane landing"; Third, the December meeting will release more signals. Currently, the Republican Party is very likely to take the House of Representatives, and if so, the parameters of the Federal Reserve model may see more changes, which will be reflected in the December dot plot and SEP.

Market reaction is calm: U.S. Treasury yields slightly down, dollar down, gold and U.S. stocks up.

After the FOMC decision announcement and Powell's speech, various asset fluctuations were not significant. The yields on 3M, 2Y, and 10Y U.S. Treasuries fell by 1, 6, and 11 basis points to 4.63%, 4.21%, and 4.31%, respectively; the dollar index fell by 0.63% to 104.49; COMEX gold rose by 1.41%; the three major U.S. stock indices, S&P 500, Nasdaq, and Dow Jones, closed up by 0.74%, 1.51%, and 0.00%, respectivelyJudgment on Various Assets: Volatility in U.S. stocks may intensify, and U.S. Treasury yields may fluctuate downward due to the partial pricing in of a slowdown in interest rate cuts.

The "Trump trade" after the election has triggered a market Risk on, but subsequent volatility will also increase. If U.S. stocks decline, it indicates the beginning of pricing in policy uncertainty and the Federal Reserve's re-adjustment of interest rate cut expectations, which may lead to a global Risk off. U.S. Treasury yields may still fluctuate downward, as the previous rebound may have partially priced in the outlook for a slowdown in interest rate cuts. The RMB exchange rate may continue to fluctuate in the range of 7.0-7.3.

Risk Warning:

U.S. economic performance exceeds expectations, and Federal Reserve monetary policy exceeds expectations