Tianfeng: How to understand the Fed's 50bp rate cut?

Tianfeng released a research report stating that this is not a compensatory interest rate cut. If the Federal Reserve really believes that the July non-farm payroll data points to the need for a rate cut, they should openly guide more specific rate cut expectations (25bp+25bp) after the data is released, rather than the market still speculating on the possibility of a 25bp or 50bp cut after the quiet period. Overall, this may be a significant rate cut driven by non-economic factors, which may also increase the risk of secondary inflation. The U.S. economy, stimulated by the rate cut at a relatively high level, may lead to a rebound in demand and inflation, and the Federal Reserve may consider raising rates again next year. The significant rate cut and rate hike fluctuations are similar to those led by Fed Chairman Burns in the 1970s. The main points of Tianfeng are as follows: The Federal Reserve unexpectedly cut rates by 50bp at the September FOMC meeting, raised the year-end unemployment rate forecast to 4.4% (from 4.0% in June), lowered the year-end core PCE to 2.6% (from 2.8% in June), and further raised long-term interest rates to 2.9%; after the Jackson Hole meeting, the Fed announced the victory over inflation by substantially cutting rates by 50bp, thus opening a new rate-cutting cycle. Throughout the press conference, Powell did not provide strong arguments for a 50bp rate cut, only emphasizing repeatedly to "do the right thing." However, based on recent economic indicators, a 50bp rate cut "may not be correct." Since August, core inflation has rebounded, wage growth has rebounded, employment conditions have improved, retail has exceeded expectations, the entire real estate chain has warmed up, the service sector PMI remains at a high expansion level, and industrial production has recovered beyond expectations, all of which show that a drastic rate cut is not urgent. The reasons behind Powell's decision may be influenced by three "non-economic factors": market expectations, illegal immigration, and the U.S. presidential election. Firstly, the market expectations were taken into account too early. It was mentioned before that "after Powell's dovish turn in August, the market did not care about the reasons and consequences of the rate cut, only speculated on the magnitude of the rate cut, so the market reaction to economic data was not symmetric."; this led to the year-end rate cut expectations since August remaining at around 100bp levels despite the improvement in economic data. Next, during the quiet period, without any data support, with the blowing of the former president of the New York Fed and other media, the expectation of a 50bp rate cut continued to rise, which lacked logical support. Powell chose to lean towards a 50bp rate cut, which lacked even more logical support, especially given that the Fed usually engages in "expectation management" proactively, he still chose to do so in this case. Understanding Powell's decision requires going back to the bottom-line goal of the Federal Reserve: financial (market) stability. The 50bp rate cut is one side of the coin that conforms to the early pricing of the financial markets and avoids large asset fluctuations; the other side is to increase potential secondary inflation risks, of which the Fed's weight on the former is clearly higher. Secondly, the elusive factor of illegal immigration (and the corresponding level of unemployment). The Fed's stable 4.4% unemployment rate forecast for 2024 and 2025 is inherently inconsistent because historically, the unemployment rate is difficult to remain constant. However, history has never seen such a massive labor supply shock, and the unemployment rate is filled with too much uncertainty. The rise in the unemployment rate is a known fact, and it has been repeatedly argued from various angles that this is more of a supply shock. The problem lies in the entire U.S. labor market being influenced by the unpredictable influx rate of illegal immigrants (including the time it takes for illegal immigrants to convert into labor, as well as the participation rate level), and the number of illegal immigrants recorded by the current U.S. Border Patrol has significantly diminished. Such bold monetary policy adjustments and a relatively aggressive rate-cutting path may not have fully taken into account the weakening marginal supply of labor, coupled with the demand recovery brought about by the rate cut, there is a certain risk of a downward turn in the U.S. unemployment rate. Lastly, and most importantly, is the factor of the U.S. presidential election. Interestingly, Powell mentioned during a press conference that as the Fed Chairman, he has experienced four presidential elections, each time based on a collective decision to maximize the interests of the American people. However, in 2016, the Fed made great efforts to avoid interference in the election, and only continued to raise rates after the election; and for the current U.S. economy, it may not be inappropriate to wait until November to take action. Looking back now, Powell's notion of "doing the right thing" is not necessarily based on economic factors, but rather more on "preferences" driven by non-economic factors. Powell has maintained a vague position during the Biden vs. Trump election battle, and after Harris took over to confront Trump, his stance quickly turned dovish, opening the rate-cutting cycle with a 50bp cut. While not emphasizing causality, the turning points in time do seem relatively consistent. Previously, Trump had threatened to replace Powell and publicly urged Powell not to cut rates before the election, which may have "backfired" and to some extent contributed to this 50bp rate cut. This is also not a compensatory rate cut. If the Federal Reserve really believes that the July non-farm payroll data points to the need for a rate cut, they should openly guide more specific rate cut expectations (25bp+25bp) after the data is released, rather than the market still speculating on the possibility of a 25bp or 50bp cut after the quiet period. Furthermore, the continued emphasis on the improvement in economic data since July has reduced the necessity for a compensatory rate cut. Overall, this may be a significant rate cut driven by non-economic factors, which may also increase the risk of secondary inflation. The U.S. economy, stimulated by the rate cut at a relatively high level, may lead to a rebound in demand and inflation, and the Federal Reserve may consider raising rates again next year. The large fluctuations in rate cuts and hikes are reminiscent of Fed Chairman Burns in the 1970s. Of course, this may also be a high probability result of the Federal Reserve's inner anchor to prevent the U.S. economy from crashing and adjusting monetary policy based on non-economic factors. Risk warning: Significant deviations in U.S. unemployment data, U.S. corporate profit slowdown exceeding expectations, unexpected events in the U.S. election, increased uncertainty in U.S. wage growth.