The Federal Reserve Becomes a Market "Follower"

The Federal Reserve under the Waller era is rewriting the logic of market pricing.

Zhang Jingjing and Wang Luobin from the macro team at China Merchants Securities, in their commentary on the July FOMC meeting released on July 30, pointed out that the real point of attention in this rate decision meeting was not the decision to hold rates steady, but rather Federal Reserve Chair Waller's first systematic exposition of a brand-new policy reaction function. Compared to the Powell era, the Federal Reserve is no longer willing to provide the market with a clear policy path; market interest rates are gradually replacing the federal funds rate as the primary vehicle for tightening or easing financial conditions.

The July FOMC meeting kept interest rates unchanged, with the statement wording remaining virtually unchanged, still emphasizing robust expansion in economic activity and strong productivity and capital investment. However, officials Hammack, Kashkari, and Logan supported a 25 basis point rate hike, marking a rare three-vote dissent in recent years and reflecting widening divisions within the committee regarding inflation risks.

China Merchants Securities believes that understanding the policy framework of the Waller era is a key prerequisite for current market pricing. He emphasized that the significant rise in nominal and real yields on U.S. Treasuries during the past two meetings means that "the market has already completed part of the tightening for the Federal Reserve," and the impact of monetary policy on financial conditions is increasingly being realized through market interest rates rather than policy rates.

The Market Is "Hiking Rates" for the Federal Reserve

The report argues that the reaction function in the Waller era stands in sharp contrast to that of the Powell era.

On one hand, the Federal Reserve no longer maintains a high tolerance for inflation caused by supply shocks, but instead focuses more on whether inflation is spreading from specific sectors to the broader economy; on the other hand, compared to the past emphasis on employment and financial market volatility, Waller places greater emphasis on the market's own role in adjusting financial conditions, with the Federal Reserve deliberately downplaying its role as a market "put option."

Under this framework, there are two main trigger paths for future rate hikes: first, new inflation metrics are officially launched and show a resurgence in inflationary pressure; second, existing high inflation is confirmed to have spread to a wider range of goods and services. Until then, holding interest rates steady remains the baseline scenario.

China Merchants Securities also warns that the U.S. economy is entering a stage where "growth factors" and "recession factors" are playing out simultaneously. Since the fourth quarter of last year, the U.S. personal savings rate has fallen below 4%, and the support of AI investment for economic growth may marginally weaken in the coming months.

Regarding asset allocation, the report remains bullish on oil-related assets and believes that if the AI industry chain releases positive signals, the Nasdaq still has room for a phased rebound; however, the growth rate of global capital expenditure may peak in the third quarter, warranting heightened vigilance in the fourth quarter. For U.S. Treasuries, as the Federal Reserve cancels forward guidance and its reaction function changes, the overall central tendency of the yield curve is expected to continue rising. If expectations for future rate hikes further intensify, a renewed inversion of the curve warrants medium-term attention.