Zhongjin: The Federal Reserve controls rate cuts under the supply problem

CICC released a research report stating that the Federal Reserve lowered interest rates by 25 basis points in September, in line with market expectations. The Federal Reserve has responded well to market concerns but also showed restraint. The expected 50 basis point rate cut did not materialize, and there is significant disagreement among policymakers regarding further rate cuts. Looking ahead, due to excessively weak employment data, CICC predicts that the Federal Reserve may cut rates again in October. However, after that, rising inflation may raise the threshold for rate cuts, and the space for monetary easing may be limited. The underlying issue in the current U.S. economy is not insufficient demand but rising costs. Excessive monetary easing not only fails to address employment issues but may exacerbate inflation, leading the economy into a "stagflation-like" dilemma. Key points from CICC: Before this meeting, there were high expectations in the market for a rate cut by the Federal Reserve due to weak labor market conditions. Investors generally believed that the Federal Reserve must act now to prevent further deterioration in employment data. We believe that the Federal Reserve has responded well to market concerns while also maintaining restraint. From a policy stance, the Federal Reserve lowered rates on schedule and cited slowing employment as the reason for the rate cut. The monetary policy statement stated that policymakers believed "downside risks to employment have increased," although they also noted that "the inflation rate has rebounded and remains relatively high." In other words, concerns about a slowing job market outweighed worries about inflation and directly drove the policy adjustment. However, the expected 50 basis point rate cut did not materialize. Looking at the voting results, newly appointed FOMC member Milan voted against the cut as he advocated for a 50 basis point rate cut, aligning with market expectations of him being a "Trump mouthpiece". However, previous advocates of earlier rate cuts in July, Waller and Bowman, did not support a larger rate cut this time, which was seen as less dovish. Waller is a leading candidate for the next Fed chairmanship and Bowman was appointed by Trump. Their decisions diverging from Milan's stance helped alleviate market concerns about the Fed's independence. Furthermore, in terms of forward guidance, the Federal Reserve may cut rates further this year, but the path is unclear. The dot plot shows that officials forecast the median federal funds rate to be 3.6% at the end of the year, indicating two more rate cuts. However, of the 19 officials who provided rate forecasts, one advocated for a 125 basis point rate cut before the end of the year (considering Milan's support for a 50 basis point cut, this outlier point may be Milan), while 9 others suggested two more cuts and 9 others believed in only one cut or no more cuts. Excluding the extreme forecast of 125 basis points, officials' opinions are almost evenly split. This suggests that the probability of another rate cut before the end of the year is higher, while two cuts seem more like a "coin toss". Overall, the Federal Reserve's decision and forward guidance were relatively conservative. Despite significant internal disagreements and intense debates, Powell remained calm. At the same time, the Fed did not show an overly stimulative attitude and continued to speak through data, which helped alleviate market concerns about being dictated by the President and contributed to market stability. Powell's performance at the press conference was also composed and restrained, showcasing the Fed's independence and rationality. Looking ahead, we predict that due to excessively weak employment data, the Federal Reserve may cut rates by 25 basis points again in October. However, after that, rising inflation may raise the threshold for rate cuts, and the space for monetary easing may be limited. We believe that the underlying issue in the current U.S. economy is on the supply side rather than the demand side; the main problem is not insufficient demand but rising costs. One piece of evidence is that employment data has been weak, but consumer spending remains resilient. If the weakness was due to demand, logically, we would see a decline in consumption first followed by an impact on employment. However, the reality is the opposite: tariffs have increased business costs, leading to reduced hiring and a slowdown in employment, while consumer spending as a lagging indicator of employment has not been significantly impacted. Another observation is that while employment growth has slowed, wage levels remain steady, and the unemployment rate has not increased significantly. This is due to tightening immigration policies reducing labor supply, while tariff impacts reduce labor demand, resulting in a dual effect. At the macro level, this translates to a decrease in total supply, with adjustments to total demand lagging, putting upward pressure on prices. A third observation is that enthusiasm in areas such as artificial intelligence (AI) and cryptocurrencies remains high, with signs of excessive optimism and overinvestment in some areas. This supports short-term demand but also implies upward pressure on inflation. Excessive monetary easing not only fails to solve employment issues but may exacerbate inflation, leading the economy into a "stagflation-like" situation. We do not rule out a scenario where, under the influence of tariffs and immigration policies, inflation continues to rise despite Federal Reserve rate cuts, while employment recovery is slow, further forming a "stagflation-like" trend. Of course, this situation will not be as severe as that of the 1970s, but its long-term, structural, and subtle nature is still cause for concern. Looking further ahead, in the context of deglobalization and geopolitical economic competition, supply shocks may persist in the long term, exacerbating economic cycles and market volatility, presenting more challenges for monetary policy.