Special topic: the Fed keeps its benchmark interest rate unchanged and slows down the pace of table contraction from June.
Transferred from: macro Research of Huatai Securities
Core viewpoints
In the early morning of Thursday, May 2nd, Beijing time, the Federal Reserve FOMC decided to keep the benchmark interest rate at 5.Mobilegameearncrypto.25% Mutual 5.5% rangeMobilegameearncryptoIn terms of contraction, as we expected in the May FOMC preview, the Fed began to slow its monthly contraction ceiling from $95 billion (60 billion Treasury bonds + 35 billion MBS) to $60 billion (25 billion Treasury bonds + 35 billion MBS) in June, and principal income exceeding the MBS limit will be reinvested in the treasury bond market. At a news conference, Powell said that even if inflation is no longer falling, the Fed will keep interest rates at current levels and the possibility of another rate rise is low (unlikely). We interpret it as follows:
Overall, the Fed's May decision was basically in line with market expectations, but Powell's position at the press conference was dovish. For the market, the most important effect of this FOMC is to "narrow" the path speculation of the Fed's possible policy path, from the previous more "divergent" path assumption, including raising interest rates, to "divergence only at the point when interest rates are cut". Powell said that the repetition of the inflation data in the first quarter should not be over-interpreted, while stressing that wage inflation is trending down and rent inflation will continue to decline, inflation is still expected to fall this year. As of 7:30 Beijing time, the probability of an interest rate cut in September had fallen slightly to 65 per cent compared with before the meeting, while two-year and 10-year Treasury yields fell 4bp and 2bp to 4.96 and 4.63 per cent, respectively (chart 1). Considering the subsequent US election agenda, we believe that the current path of interest rate cut in the market may be the result of the weighted average of the possibility of "cutting interest rates twice in July" and "not cutting interest rates" (binary). The Fed still tends to be dove, and which path is more likely to occur in the end will depend on the trend of inflation from April to May.
On the growth side, the Fed is still relatively positive about the growth outlook, and Powell stressed the possibility of a soft landing. Mr Powell said that although the GDP figures were weaker than expected, private domestic purchase demand, which is more indicative of potential demand (GDP excluding inventory, government purchases and net exports), maintained strong growth since the second half of 2023. Although high interest rates have some constraints on investment in housing and equipment, consumption remains resilient and continued improvement in supply also supports growth. In the labour market, employment is still tight but labor rebalancing continues: the labor participation rate between the ages of 25 and 54 continues to improve and the continued inflow of immigrants has contributed to a significant increase in labor supply. on the other hand, the slowdown in nominal wage growth and the narrowing of the job and employment gap indicate a "labor shortage" or marginal easing, but labor demand still exceeds supply.
On the inflation front, Powell admitted that the progress of inflation has stalled recently, but still expects inflation to fall back in the future. In the FOMC statement, the Fed added the phrase "lack of further progress in inflation in recent months (lack of further progress)". Powell said higher-than-expected inflation in the first quarter suggested that loose financial conditions at the end of last year may be behind it. Powell still predicts that inflation may cool this year: for example, wage growth will continue to slow and housing inflation will lag behind. In terms of inflation expectations, Powell said that short-term inflation expectations have accelerated recently, but medium-and long-term inflation expectations remain relatively stable.
Looking forward, monetary policy can be summed up as the threshold for delaying interest rate cuts is not high, while the threshold for raising interest rates is high. The former is in line with market expectations; the latter alleviates some of the market concerns. Powell said that the higher-than-expected inflation since the beginning of the year has led to a decline in the Fed's confidence that inflation will return to its target, that it may take longer than previously expected for the Fed to have enough confidence to cut interest rates, and that the Fed may delay the rate cut. In addition, Powell believes that it is unlikely to raise interest rates again: the current monetary policy is still restrictive, the economy continues to be strong, and the stagnant progress in inflation will only cause the Federal Reserve to delay cutting interest rates; reconsidering raising interest rates requires convincing evidence that current interest rates are not sufficiently restrictive to keep inflation down to 2%. The outlook for the Fed rate cut depends on the job market and inflation data, such as substantial and unexpected weakness in the labour market and a return to last year's downward trend in inflation.
To sum up, the FOMC signal is slightly neutral, and for the market, the most important effect of this conference is to "narrow" the market's guess on the Fed's path since then, basically ruling out the possibility of raising interest rates-although the final weighted average rate cut expectations have changed little, the meeting reduced the diversity of market expectations and reduced the risk premium at the margin. As we predicted before the meeting ("May FOMC Preview: interest rate cut still needs to be observed, but Taper may be announced", 2024-4-28), the Fed's recent postponement of interest rate cut expectations is a reasonable and inevitable response to the high growth and inflation data in the first quarter, considering that the Fed believes that the current policy is already in a restrictive range, and if subsequent data allow, the Fed still has a strong willingness to start cutting interest rates this year. Powell's speech showed that the two possible scenarios for the Fed to cut interest rates are a substantial slowdown in the job market, a faster-than-expected slowdown and a return to a downward trend in inflation. Recent employment data show that job creation remains strong, but this may be related to structural changes in the influx of immigrants. the Fed may be less sensitive to this (see the United States: the macro impact of population inflows, 2024-4-21). At the same time, the Fed's more focused wage trend shows that the overall job market continues to cool. We will closely monitor whether the non-farm data released tomorrow (May 3) further validate this trend. Considering the subsequent US election agenda, we believe that the current path of interest rate cut in the market may be the result of the weighted average of the possibility of "cutting interest rates twice in July" and "not cutting interest rates" (binary). The Fed still tends to be dove, and which path is more likely to occur in the end will depend on the trend of inflation from April to May. If inflation can remain below 0.3% from April to May (that is, below 3% on an annualized basis), there is still a certain probability of interest rate cut in July, but if it continues to be higher than 0.3% (annualized 3-4%), it is less likely to cut interest rates in July.
Risk tip: inflation stickiness leads to higher-than-expected hawks in the Fed and high interest rates expose financial risks in the United States.
Appendix: comparison of May and March FOMC statements
Recent indicators suggest that economic activity has been expandingcontinued to expand at a solid pace． Job gains have remained strong， and the unemployment rate has remained low． Inflation has eased over the past year but remains elevated． In recent months， there has been a lack of further progress toward the Committee‘s 2 percent inflation objective．
The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run． The Committee judges that the risks to achieving its employment and inflation goals are moving intohave moved toward better balance over the past year． The economic outlook is uncertain， and the Committee remains highly attentive to inflation risks．
In support of its goals， the Committee decided to maintain the target range for the federal funds rate at 5-1/4 to 5-1/2 percent． In considering any adjustments to the target range for the federal funds rate， the Committee will carefully assess incoming data， the evolving outlook， and the balance of risks． The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent． In addition， the Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage backed securities， as described in its previously announced plans．Beginning in June， the Committee will slow the pace of decline of its securities holdings by reducing the monthly redemption cap on Treasury securities from $60 billion to $25 billion． The Committee will maintain the monthly redemption cap on agency debt and agency mortgage backed securities at $35 billion and will reinvest any principal payments in excess of this cap into Treasury securities． The Committee is strongly committed to returning inflation to its 2 percent objective．
In assessing the appropriate stance of monetary policy， the Committee will continue to monitor the implications of incoming information for the economic outlook． The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee‘s goals． The Committee’s assessments will take into account a wide range of information， including readings on labor market conditions， inflation pressures and inflation expectations， and financial and international developments．
Voting for the monetary policy action were Jerome H． Powell， Chair； John C． Williams， Vice Chair； Thomas I． Barkin； Michael S． Barr； Raphael W． Bostic； Michelle W． Bowman； Lisa D． Cook； Mary C． Daly； Philip N． Jefferson； Adriana D． Kugler； Loretta J． Mester； and Christopher J． Waller．