Minsheng Securities: Internal disagreements are key focus for the Fed's interest rate meeting in July.

The July interest rate meeting was both "lackluster" and "full of highlights". The lack of suspense lies in the fact that whether it's from the already published inflation and non-farm data, or the recent statements from Federal Reserve officials (more in favor of waiting), not lowering interest rates was almost a foregone conclusion before the meeting. However, the highlights lie in how Federal Reserve Chairman Powell and even the Fed as a whole will "take chestnuts out of the fire": managing to maintain independence without being accused of losing it, while also safeguarding the overall US economy. Making a rate cut that is convincing to everyone may be Powell's most core challenge remaining in his term. The July interest rate meeting was an important test. Powell demonstrated a "hawkish" and "dovish" side, being "hawkish" in not budging on lowering interest rates and not bowing to pressure, while being "dovish" in lowering the threshold for a shift in Fed policy - if the data in the next two months (before the September interest rate meeting) is not favorable, it could still be a reason for cutting rates, which was not sufficient in previous years. However, at present, the market seems to value the "hawkish" side more, as evidenced by the overnight surge in the US dollar index to nearly 100; but it is worth noting that a reversal of expectations may only require one disappointing non-farm data release. Specifically: Firstly, the FOMC meeting in July was like a game of "Werewolf". The most eye-catching aspect was the usually united Fed, which saw two board members vote against keeping rates unchanged, which is rare in the past 30 years. However, this result was somewhat expected, as Clarida and Bullard had almost clearly stated their support for a rate cut before the meeting. Nevertheless, this result already fully reflects the significant internal divisions within the Fed, with some board members either anxious about economic downturn and employment risks, or succumbing to political pressure, starting to waver on whether to cut rates. Secondly, Powell's language regarding economic outlook has also changed. In terms of the economy, Powell acknowledged the current trend of slowing growth, which is consistent with the meeting statement of "slowing economic activity in the first half of the year", but he places more importance on the performance of the labor market. Looking at the increase in non-farm payrolls, there are indeed downside risks in the job market, but this could be the result of both supply and demand weakening. The Fed will further observe the potential risks in the job market based on changes in indicators such as unemployment rate and wages; as for inflation, Powell believes that the impact of tariffs on prices is more likely to be one-off, but it is necessary to prevent it from becoming a sustained inflation issue through monetary tools. Thirdly, in the post-meeting press conference, Powell further downplayed external political pressure, including the issue of excessive Fed renovation costs and the speculation of an early resignation. Recently, Trump even made a rare appearance directly confronting Powell. Obviously, Powell has to consider the impact of these issues on his leadership and the Fed's reputation, but the seasoned Powell tried to focus as much as possible on economic data-driven decision-making, while further defending the Fed's independence during the meeting, emphasizing the importance of maintaining central bank independence. Looking ahead, it is crucial for both the Fed and the market to objectively evaluate the subsequent US macroeconomic fundamentals. For the September FOMC meeting, Minsheng Securities and the market hold a consensus view that a rate cut is the base case. If the hesitancy of the Fed before the July meeting was more due to concerns about unknown inflation risks, and now with the uncertainty of tariff rates greatly reduced, the only real economic impact that could influence monetary policy is the actual economic effects brought by tariffs: Firstly, in terms of inflation, the major uncertainty for the Fed this year has been the extreme uncertainty of the tariff policy itself, leading to the Fed "waiting and seeing" (maintaining interest rates unchanged for the fourth consecutive FOMC since December last year). As Powell himself acknowledged, if not for the tariffs, the Fed might have started cutting rates earlier. This uncertainty seems to have been reduced by Trump himself. Although the trade negotiations are not yet fully concluded, with major countries such as Japan, Europe, South Korea, and Southeast Asian countries reaching trade agreements with the US, Trump seems to be able to declare victory on the tariff policy. Minsheng Securities expects the trade negotiations to gradually enter the final stage, with more and more small and medium-sized countries finding it difficult to withstand the tariff pressure brought by Trump, and eventually compromising or backing down. This has reduced the difficulty of Fed decision-making, as the current trade agreement template roughly sets the target tariff rate range for the Fed, i.e. a 10-20% tariff rate. This allows the Fed to better evaluate the extent of future inflationary pressures, rather than shooting in the dark. Moreover, compared to the "Independence Day" scenario, the current tariff rates have a much smaller "disruptive" effect than the worst-case scenario. Secondly, although the uncertainty is less than before, the tariff rates have actually been increased compared to before Trump took office. In the short term, the transmission of tariffs to inflation is slow due to factors such as the impact on the supply side (stockpiling of imported goods leading to overseas exporters lowering prices), but it is not nonexistent. This phenomenon can already be seen from the rising core goods CPI in June on a year-on-year basis, so the probability of a sudden and sharp rate cut by the Fed is low, as reflected in the consistent expectations shown in the derivatives market. However, for the Fed, if inflation remains mild in the next two months, attention will shift moderately towards economic growth. Although the pressure from the cost side of imports (unchanged import prices + rising tariffs) is beginning to show, price increases are unavoidable. But as long as inflation can remain mild and gradually increase, it will not have a directional impact on monetary policy. Minsheng Securities expects that the probability of a spike in inflation data (in July and August) before the September meeting is low. There are no signs of a rapid increase in high-frequency price data for July, and subsequent tariffs are unlikely to be added directly to prices. Limited by constrained demand and suppressed inflation expectations, there may be some negative feedback in the market due to earlier exhaustion of demand driven by import purchases and consumption. Excluding seasonal factors, demand in August may continue to show a slight slowdown trend. Lastly, what may be more difficult to evaluate is employment. Although non-farm payrolls are trending downwards, it is not just demand that is at play; factors like Trump's immigration restrictions since the beginning of the year have also reduced labor supply (the impact of changes in labor force participation rates on unemployment and new job creation cannot be ignored). Under a backdrop of weak supply and demand, attention should be paid to indicators such as the unemployment rate, wage growth, and vacancy-to-job-seeker ratio. Looking at recent data, although the labor market growth is slowing, the level of tightness is decreasing, but there are no signs of a significant deterioration. In the remaining months of the year, the weight of such indicators in Fed decision-making may increase. In conclusion, due to the numerous noise and uncertainties, including Powell and other Fed officials, although they have not cut rates so far, they hold an open attitude towards a rate cut this year. The previous hesitation was likely due to reluctance to bear the uncertainty caused by Trump. Now that the dust may settle on the tariff issue, once clearer signals appear in the data, the Fed may act decisively. This article is reprinted from the public WeChat account "Reading the Global Macro", authors: Lin Yan, Shao Xiang, Wu Shuo; GMTEight Editor: Xu Wenqiang.