CITIC Securities Co., Ltd.: The Federal Reserve is highly likely to pause interest rate cuts at the next meeting, and volatility in the U.S. stock market is expected to increase

According to the Zhitong Finance APP, CITIC Securities released a research report stating that the Federal Reserve is expected to cut interest rates by 25 basis points at the December 2024 meeting, in line with market expectations. The latest dot plot indicates that the target interest rate center for next year is 3.9%, higher than the 3.4% shown in the September 2024 meeting, while also raising the inflation and economic growth forecasts for next year and lowering the unemployment rate forecast. Powell's remarks did not provide clear guidance on the "extent and timing" of future rate cuts, but he expressed strong confidence in economic growth. From the SEP and Powell's statements, it is evident that the Federal Reserve has significant concerns about inflation next year. This meeting was much more hawkish than the market generally expected, but it aligns with the view that the Federal Reserve will cut rates twice in 2025. The firm continues to maintain this view and expects that the Federal Reserve will likely pause rate cuts at the next meeting to observe, or may need to wait until the March meeting to provide clearer guidance, with increased volatility expected in the U.S. stock market.

CITIC Securities' main points are as follows:

Key points from the Federal Reserve's December 2024 meeting statement:

1. In terms of interest rate tools, the committee decided to lower the target range for the federal funds rate to 4.25-4.5%, in line with market expectations. This rate decision did not receive unanimous consent from FOMC members, with Cleveland Fed President Mester leaning towards keeping rates unchanged.

2. Regarding the balance sheet, the committee maintained the pace of balance sheet reduction, with a monthly redemption cap of $25 billion for U.S. Treasuries and $35 billion for agency debt and MBS. The overnight reverse repurchase rate was lowered by 30 basis points, a technical adjustment aligning with the lower bound of the federal funds rate target range.

3. On the economic outlook, recent indicators suggest that economic activity continues to expand at a steady pace. Job growth has slowed, and the unemployment rate has risen, but remains low. The inflation rate is moving closer to the committee's 2% target, but is still somewhat high. The committee seeks to achieve maximum employment and a 2% inflation rate in the long term. The committee's confidence in inflation moving towards 2% has strengthened, and it assesses that the risks to achieving employment and inflation targets are roughly balanced. The economic outlook is uncertain, and the committee notes the risks facing its dual mandate.

4. The changes in the December 2024 Federal Reserve meeting statement compared to the previous meeting are minimal, merely changing "When considering additional adjustments to the target range for the federal funds rate, the committee will carefully assess incoming data, evolving outlooks, and risk balances." to "When considering the extent and timing of additional adjustments to the target range for the federal funds rate, the committee will carefully assess incoming data, evolving outlooks, and risk balances."

The latest dot plot indicates that the target interest rate center for next year is 3.9%, higher than the 3.4% shown in the September 2024 meeting, while also raising the inflation and economic growth forecasts for next year and lowering the unemployment rate forecast.

The dot plot expects the terminal rate in 2025 to be 3.9%, higher than the 3.4% indicated in the September meeting, implying another 50 basis points of rate cuts next year. From the specific voting patterns in the dot plot, there is 1 vote for maintaining 4.25-4.5% in 2025, 3 votes for an additional 25 basis points cut, 10 votes for 50 basis points, 3 votes for 75 basis points, 1 vote for 100 basis points, and 1 vote for 125 basis points In addition, it is worth noting that this time the dot plot has raised the long-term interest rate level again, from 2.9% to 3.0% (the September SEP was raised from 2.8% to 2.9%), which may indicate that the Federal Reserve has once again increased its assessment of the long-term neutral interest rate level. In terms of economic forecasts, compared to the September 2024 meeting, this meeting slightly raised the GDP growth forecast for 2025 and lowered the unemployment rate forecast for next year. Regarding inflation forecasts, the year-on-year growth rate of PCE for next year was raised from 2.1% in September to 2.5%, and the core PCE year-on-year growth rate was raised from 2.2% in September to 2.5%.

Powell's remarks did not provide clear guidance on the "magnitude and timing" of future rate cuts, showing strong confidence in economic growth but insufficient confidence in inflation.

First, regarding interest rates, Powell did not provide clear guidance on the newly added "magnitude and timing" of rate cuts in the statement from this meeting. In terms of magnitude, he stated that the two rate cuts indicated in the current SEP for next year are not guaranteed, and there was almost no incremental information regarding timing. When discussing interest rates, Powell mentioned four factors: economic growth, the labor market, inflation, and neutral interest rates, believing that being close to the neutral interest rate is one of the reasons for caution in rate cuts. However, when asked about the level of the neutral interest rate, Powell did not provide a clear answer.

Additionally, Powell stated that it is unlikely to raise interest rates in 2025. Secondly, regarding the labor market and economic growth, Powell's description of economic growth was positive (very very good, remarkable), indicating that the labor market is weakening moderately, and the current situation is not as tight as in 2019, with diminished downside risks in the labor market. Finally, on the issue of inflation, Powell frequently reviewed the progress made in inflation, stating that it may take another year or two to reach the 2% inflation target. From his remarks, it appears that he lacks confidence in the inflation outlook and, in a rare horizontal comparison, indicated that other countries are also facing inflation issues. Only after being questioned by reporters did he use the term "confident" to state that "inflation is on track to return to the 2% target," and the SEP forecast also shows that reaching the 2% inflation target has been postponed from 2026 to 2027.

From the SEP and Powell's remarks, it is clear that the Federal Reserve has significant concerns about inflation next year. This monetary policy meeting was much more hawkish than the market generally expected, but it is consistent with the view that the Federal Reserve will cut rates twice in 2025, and this view is maintained.

First, the market's expectation for this meeting was a hawkish cut; however, the information presented at this meeting is evidently more hawkish than the market expected. On one hand, the 10 voting members only expect two rate cuts next year, which is more hawkish than the general market view that the dot plot would show three rate cuts. Secondly, the upward adjustment of inflation in this SEP is significantly greater than the upward adjustment of economic growth, indicating the Federal Reserve's concerns about inflation. The relative importance of inflation and unemployment in the eyes of the Federal Reserve may have flipped again, and the inflation expectations brought by Trump may become an unavoidable concern. Powell believes that the downside risks in the labor market have diminished and that economic growth is stronger than previously expected; thus, the hawkish message from this meeting comes from concerns about inflation next year. Thirdly, a reporter noted that the absence of the term "recalibration" in this speech may indicate a new phase The bank believes that based on Powell's speech this time, the Federal Reserve has clearly entered a new phase, one that is relatively ambiguous and lacks clear forward guidance, which is a more unfavorable signal for the market than a 25bps rate cut below market expectations indicated by the dot plot.

It is expected that the Federal Reserve will most likely pause rate cuts at the next meeting to observe, and clearer guidance may not be provided until the March meeting, with increased volatility anticipated in the U.S. stock market.

After the December interest rate decision was announced, the U.S. stock market fell sharply, with the Nasdaq down 3.56%, the S&P 500 down 2.95%, and the Dow down 2.58% (10 consecutive days of decline). The U.S. dollar index rose above 108, and the yields on 10-year and 2-year U.S. Treasury bonds surged. In the short term, under the unclear guidance from the Federal Reserve, the optimistic "holiday trading" sentiment in the U.S. stock market may come to an end, with increased market volatility expected. The next FOMC meeting is scheduled for January 29 in U.S. time, which is shortly after Trump's inauguration. Given the limited changes in economic data, the bank expects that the Federal Reserve will most likely pause rate cuts at that time to observe, and clearer guidance may not be provided until the March FOMC meeting.

Risk factors:

U.S. inflation rebounds beyond expectations; U.S. financial system vulnerabilities exceed expectations; U.S. labor market weakens beyond expectations