GF SEC: The Federal Reserve's Shift and Future Policy Rate Path

GF SEC released a research report stating that during the Federal Reserve's September 2024 meeting, most FOMC officials voted to lower the federal funds rate target range to 4.75%-5.0%, the first rate cut since the rate hike cycle started in March 2022, signaling the start of a new policy cycle. Powell stated that the focus of Fed policy has shifted from controlling inflation to preventing substantial weakening of employment risks, but the pace of rate cuts is orderly, and a soft landing remains the base case. In the medium term, factors such as immigration, labor productivity, and capital expenditure lead GF SEC to believe that the neutral interest rate should increase, with the long-term policy rate forecasted in the SEP to be 2.9%, higher than the pre-pandemic rate of 2.5%. First, at the September 2024 Fed meeting, most FOMC officials voted to lower the federal funds rate target range to 4.75%-5.0%, down from 5.25%-5.5%. Market expectations before the decision were a 63% probability of a 50bp rate cut and a 37% probability of a 25bp cut, marking the first rate cut since the rate hike started in March 2022. Second, during the press conference, Powell took a slightly hawkish stance and provided explanations for the significant rate cut to avoid market interpretation as a recession risk. Powell stated that the economy is solid and that the Fed policy rate is not behind the curve. He also explained that the rate cut was more about risk management considerations and recalibrating policy stance towards risk prevention and employment risk mitigation, with the process being gradual. When asked about what information or data could lead to another significant rate cut, Powell mentioned the Beige Book and downward revisions in non-farm payroll data as areas of focus, indicating that the current non-farm payroll figures are likely overestimated, and the preemptive rate cut is aimed at avoiding risks of deterioration in the job market. Third, the September FOMC statement exhibited a stronger risk management stance and emphasized the Fed's willingness to support full employment. The statement noted progress towards the inflation target and balanced inflation and economic risks, showcasing a commitment to maximum employment support. The Fed maintained its balance sheet reduction pace, with monthly redemption limits for treasuries and MBS set at $250 billion and $350 billion, respectively. Fourth, the dot plot in September slightly leaned hawkish in future rate cut guidance. According to the dot plot, the pace of future rate cuts should be gradual, with the terminal policy rate expected to be higher than pre-pandemic levels. The dot plot indicated two more rate cuts in 2024, bringing the year-end policy rate to 4.375%, with further cuts of 100bp in 2025 and 50bp in 2026, leading to policy rates of 3.375% and 2.875%, respectively. While the total rate cuts for 2024-2026 were raised to 250bp, the long-term policy rate expectation was revised to 2.9%, slightly above the previous 2.8%. The median policy rate for 2026 was 3.1%, with a long-term policy rate median of 2.75%, slightly raised from the previous 2.56%. Fifth, in September, the SEP lowered inflation expectations, raised unemployment rate expectations slightly, and slightly decreased GDP forecasts, indicating a slightly weaker economic resilience than in June but still suggesting a soft landing scenario. The SEP lowered the core PCE forecasts for 2024 and 2025 to 2.6% and 2.2%, respectively, from 2.8% and 2.3% in June. Unemployment rate expectations were raised, with the 2024 rate predicted at 4.4% compared to the previous 4%, and 4.4% and 4.3% for 2025 and 2026, respectively, up from 4.2% and 4.1%. GDP forecasts for 2024 were slightly reduced to 2% from 2.1%, while growth forecasts for 2025-2026 remained at 2%. These adjustments reflect a moderately weakening economy but still indicate a soft landing. The significant adjustment in unemployment rate forecasts highlights the Fed's vigilance towards marginal changes in this area, as it is a key determinant of the pace of rate adjustments throughout the year. Sixth, overall, Powell's messages and the SEP's signals are consistent with GF SEC's previous understanding of the US economy. The research suggests that fiscal expansion and low-interest loans in the private sector have strengthened the economy post-pandemic, but as fiscal expansion benefits taper off, nominal growth will gradually slow down. While higher rates and shrinking nominal growth may soon be mismatched, the preemptive rate cut is seen as necessary and rational. Looking ahead, GF SEC believes that the neutral interest rate should increase due to factors like immigration, labor productivity, and capital expenditure, with the long-term policy rate forecast in the SEP at 2.9%, higher than the pre-pandemic rate of 2.5%. Under this neutral scenario, the actual growth rate should be slightly below the pre-pandemic level (average of 2.4% over the previous decade)., but the nominal growth rate will be slightly higher than the pre-epidemic level (average of 4.0% in the 10 years before the epidemic). The mid-term interest rate cut space of the Federal Reserve will be affected by this characteristic.Seventh, after the interest rate meeting, CME Fed Watch showed that the market expected a 68% probability of a 25bp rate cut and a 32% probability of a 50bp rate cut by the Federal Reserve in November. Due to Powell's relatively hawkish stance in the press conference, the yield on the 10-year US Treasury rose by 6bp to 3.70% after the rate cut; although the stock market rebounded significantly after the decision was announced, it closed slightly lower. The US dollar index also fell slightly. Eighth, it is noteworthy that this interest rate cut by the Federal Reserve signals the start of a new policy cycle, with significant implications. This cycle is likely to continue throughout the rest of the year and into 2025. For non-US markets, external liquidity disturbances and constraints are expected to gradually decrease; regardless of the pace and slope, the logic will gradually become more favorable. Understanding this process is important for the impact on asset pricing.