CMSC: The Fed's policy stance still has some room for maneuver and pressure on non-dollar currencies has eased for now.

The CMSC report states that overall, the Federal Reserve believes that the phase of the epidemic's impact on employment and inflation has ended; the era of forward guidance has temporarily come to an end, and the Federal Reserve is unwilling to reveal all its policy cards. The large 50BP rate cut is aimed at preventing significant fluctuations in the already anticipated US stocks and bonds markets. Powell's continued cautious approach is also aimed at preventing a situation similar to the reversal of the yen carry trade in early August due to concerns about a hard landing of the US economy. In addition, the Federal Reserve also wants to prevent the potential collapse of the US stock market's siphon effect and large-scale outflow of funds from US capital markets due to a significant rate cut. Furthermore, until US economic data significantly deteriorates, even with a large rate cut by the Federal Reserve, it may not necessarily significantly boost all non-US assets. However, it can be expected that the US dollar index is unlikely to strengthen significantly in the short term, which can help alleviate the depreciation pressure on non-US currencies. The main points of the CMSC report are as follows: Event: On September 18, 2024, the Federal Reserve held a monetary policy meeting and lowered the federal funds target rate range by 50 basis points to 4.75%-5.00%. The pace of balance sheet reduction remained unchanged, with the Fed selling $250 billion in US Treasury securities and $350 billion in mortgage-backed securities each month. Content: The Federal Reserve cut rates by 50 basis points and kept the pace of balance sheet reduction unchanged. Forecasts were lowered for core inflation in 2024-2025, while unemployment rate expectations were raised. The dot plot predicts a 100 basis point rate cut each in the current year and the next. The main changes in economic forecasts include: 1) Real GDP growth expectations for 2024, 2025, and 2026 are all at 2.0% (compared to 2.1%, 2.0%, and 2.0% in June); 2) Core PCE growth expectations for 2024, 2025, and 2026 are 2.6%, 2.2%, and 2.0% respectively (compared to 2.8%, 2.3%, and 2.0% in June); 3) Unemployment rate expectations for 2024, 2025, and 2026 are 4.4%, 4.4%, and 4.3% respectively (compared to 4.0%, 4.2%, and 4.1% in June); 4) Federal funds rate expectations for 2024, 2025, and 2026 are 4.4%, 3.4%, and 2.9% respectively (compared to 5.1%, 4.1%, and 3.1% in June). The dot plot predicts a 100 basis point rate cut in 2024 and another 100 basis point cut in 2025 (compared to a 25 basis point cut in 2024 and a 100 basis point cut in 2025 in June). Powell's speech and response to journalists signal that the balance of risk management has tilted towards employment, and rate cuts are aimed at maintaining strong employment and economic conditions. 1) Economy: No signs of a recession. Real GDP growth was 2.2% in the first half of this year, and current data indicates a growth rate close to this in the third quarter. Consumption remains resilient, equipment and intangible asset investment have rebounded, real estate has fallen slightly but improved supply conditions support demand; there are no signs indicating an increased risk of economic recession. 2) Employment: Controlling the unemployment rate is a core priority. The unemployment rate has slightly increased but remains at a relatively low level. The labor market tightness is lower than pre-epidemic levels. If the Committee had seen the non-farm employment report released after the July meeting, the Federal Reserve might have cut rates for the first time in July. A 4.2% unemployment rate is still healthy. Our goal is to maintain a healthy labor market, and a significant rise in the unemployment rate is an undesirable side effect in the process of reducing inflation. 3) Inflation: Firm confidence in the decline of inflation. The disruption of inflation by the epidemic has been eliminated, and inflation has significantly eased in the past two years but remains above the 2% target. Confidence has increased in sustainable progress towards the 2% inflation target, and the labor market is not the source of inflation pressure. Housing inflation will eventually decrease but may take some time. 4) Rate path: No preset path, moving towards normalization. This rate cut is a clear signal from the Federal Reserve that it will not lag behind the economic performance. The Federal Reserve has no preset path, and will adjust the pace flexibly based on actual conditions, either accelerating or slowing down. Monetary policy is moving towards a neutral stance, and this rate cut is just the beginning of the adjustment process. Future rate cuts will depend only on the data, and it should not be assumed that a 50 basis point rate cut is the norm. Why 50 basis points? Three reasons. Recently, US GDP and retail data have shown economic resilience, and core inflation has picked up slightly, seemingly not necessitating an urgent large rate cut. However, expectations of a 50 basis point rate cut quickly rose, and the reason is why? On the surface, Powell's strategy is to "exchange space for time," using a larger rate cut to protect the higher-risk employment sector, thereby maintaining economic resilience for a longer period. However, the most important reasons are threefold: First, Powell's statement indicates that the epidemic's impact on US inflation and labor market tightness has ended, allowing monetary policy to "normalize" and move towards a "neutral stance." Second, since the financial crisis, the Federal Reserve has often used forward guidance as an important communication tool with the market to reduce expectations gaps and lower volatility, but forward guidance has gradually become ineffective even disappearing since last year. This year, the Federal Reserve has shifted towards being "data-dependent" and not presetting a path. As the expectations for rate cuts in the US asset, represented by US stocks and bonds, have reached an extreme, excessive rate cuts may lead to a reversal of the yen carry trade, while too little rate cuts may cause assets that have already priced in more cuts to fluctuate significantly. Therefore, compared to forward guidance, sticking to data dependence and not guiding expectations is a more risk-neutral choice. Third, this round of Federal Reserve rate cuts lags noticeably behind other central banks. Since June, the ECB has significantly cut rates, and following in their footsteps, as the Federal Reserve also cuts rates, it is advantageous to maintain a relative balance between US assets represented by the dollar and non-US assets. Market reaction: Long-term US bonds, gold, and US stocks initially rose (after the decision was announced) and then fell (after Powell's speech), while the US dollar initially fell and then rose, indicating that the market interpreted the rate cut as dovish but with no further dovish signals. Interest rate market positions have largely adjusted to match rate cut expectations. After the FOMC decision and Powell's speech, various asset classes experienced increased volatility. The 3-month US bond yield fell by 11 basis points to 4.84%, and the 2-year and 10-year US bond yields initially rose after the decision was announced but fell after Powell's speech, ultimately rising by 2 basis points and 5 basis points to 3.61% and 3.70%, respectively; the US dollar index.After falling first and then rising, the final closing was down by 0.17% to 100.85; COMEX gold and COMEX silver both rose first and then fell, with intraday declines of 0.85% and 3.23% respectively; US stocks rose first and then fell, with the S&P 500, Nasdaq, and Dow Jones indexes closing down by 0.29%, 0.31%, and 0.25% respectively. The market's short-term interest rate cut expectations have not changed much, but expectations for rate cuts in the next year have declined, approaching the dot plot.Maintaining judgment on various assets: Before the election, the volatility of the U.S. stock market intensified, and it is recommended to be bullish on U.S. bonds, while non-U.S. currencies remain relatively strong against the U.S. dollar. Before the election, the volatility of the U.S. stock market may intensify, especially in carry trades involving the Japanese yen, which may reverse again. It is not ruled out that there may be a rebound before the election, but this rebound may still be a profit-taking opportunity. The yield on U.S. bonds may continue to decline, and increasing long positions on U.S. bonds during empty positions is still a relatively rational choice. The U.S. dollar index is unlikely to strengthen in the short term. Furthermore, non-U.S. currencies will also remain relatively strong against the U.S. dollar, and the bank still predicts that the RMB exchange rate will fluctuate within the range of 7.0-7.3. Risk Warning: Better-than-expected U.S. economic performance, and unexpected changes in monetary policy by the Federal Reserve.