Zhongjin: The Federal Reserve may find it difficult to cut interest rates this year, and assets driven solely by liquidity may continue to be under pressure.

CICC released a research report stating that multiple recent US inflation data have exceeded expectations, while the job market has tended to stabilize. Bond selling is occurring, and market concerns about inflation are continuing to escalate. At the same time, there has been no substantial progress in the US-Iran peace negotiations, and the Strait of Hormuz remains effectively closed, with the risk of energy prices continuing to rise. Under the baseline scenario, the bank expects US PCE inflation to remain above 3.5% for the whole year, while core PCE inflation will be above 3%, both significantly higher than the Federal Reserve's policy target of 2%. In this context, the Federal Reserve's policy stance will shift towards a more cautious direction, making it difficult for further interest rate cuts within the year (previously expected the next cut in the fourth quarter). Establishing policy credibility will be the top priority for new Chairman Powell, timely conveying clear anti-inflation signals to the market is not only necessary but also essential for stabilizing expectations. For the market, this means that the probability of marginal tightening of US dollar liquidity is increasing, and assets relying solely on liquidity may continue to be under pressure. CICC's main points are as follows: Continued escalation of inflation concerns, stable employment Recent releases of multiple US inflation data have exceeded market expectations, causing market concerns. In April, the overall CPI rose by 3.8% year-on-year, reaching the highest level since 2023; the core CPI, excluding food and energy, rose by 2.8% year-on-year, also higher than expected. As for the PPI, it showed a significant increase of 1.4% month-on-month and a year-on-year increase of 6%, the fastest growth since 2022. The import price index rose by 1.9% month-on-month and 4.2% year-on-year, also the largest increase since March 2022. Among them, the price index of goods imported from China increased by 0.8% month-on-month, marking the first positive growth since 2023. Although the above-mentioned inflation pressure mainly comes from the rise in energy prices, there are also signals of inflation spreading in the data. For example, the significant increase in food prices in April may be related to the transmission of upstream costs through fertilizers to the agricultural sector, as well as the rising costs of food transportation and logistics. Air ticket prices have been rising for two consecutive months, reflecting airlines continuing to pass on fuel cost pressures to consumers. Meanwhile, rapid expansion of AI-related demand has caused global shortages in storage and chip supply, pushing up prices for personal computers and related hardware components, further reinforcing inflation stickiness. This means that price pressures are no longer limited to the energy sector but are beginning to appear in a wider range of categories. Looking ahead, if there is no substantial breakthrough in US-Iran negotiations and the Strait of Hormuz remains closed, coupled with accelerated consumption of crude oil inventories, international oil prices will face upward pressure. Combining CICC's judgment on the future trend of oil prices, under the baseline scenario, the bank expects overall PCE inflation to rise to 3.9% in the second quarter and then fall to around 3.8% by the end of the year; core PCE inflation will rise to 4.0% in the third quarter and fall to around 3.4% by the end of the year. Under this path, inflation will continue to significantly exceed the Federal Reserve's 2% policy target, making it difficult for interest rate cuts to materialize. Another factor hindering interest rate cuts is the stabilization of the labor market. In April, the increase in non-farm employment reached 115,000, raising the average monthly increase in non-farm employment to 76,000 from January to April, a significant improvement from the average decrease of 8,000 people per month in the second half of last year. The unemployment rate remained around 4.3%, falling from the end of last year. Looking at the reasons for unemployment, the number of people permanently unemployed remained stable and did not continue to rise; weekly initial claims for unemployment benefits also remained at a low level, indicating that there was no large-scale wave of layoffs. In addition, with the Trump administration continuing to tighten immigration policies, the "tipping point" employment growth needed to maintain the stability of the unemployment rate has significantly decreasedaccording to the latest estimates from the Dallas Fed, the tipping point employment growth level in 2026 has fallen to near zero. This means that even if employment growth remains flat, the unemployment rate may not necessarily rise significantly, further raising the threshold for interest rate cuts. It will also be difficult for Powell to cut interest rates after taking office, establishing credibility is key The market is also concerned about another issue, the Federal Reserve is about to welcome new Chairman Powell, who will be able to push for earlier interest rate cuts after taking office? From Powell's standpoint, he prefers a policy combination of "interest rate cuts + balance sheet reduction," i.e., pushing for lower rates while reducing the balance sheet. However, in the current macro environment, the bank believes that even if he formally takes office, it will still be difficult for him to push for interest rate cuts in the short term. The core reason is that Federal Reserve monetary policy is not decided by the chairman alone, but by a collective vote of the Federal Open Market Committee (FOMC). At the April FOMC meeting, three regional Fed officials have opposed including loose guidance in the monetary policy statement; if the inflation outlook does not substantially improve, they are unlikely to endorse interest rate cuts. In addition, current Chairman Powell will continue to serve as a governor after leaving office, meaning that in the initial period of Powell's tenure, the internal structure of the Federal Reserve will be in a delicate transitional phase, making it difficult to form a high degree of consensus. More importantly, as the new Chairman of the Federal Reserve, Powell's top priority after taking office will be to quickly establish policy credibility. In the context of rising inflation pressure, turning a blind eye to it will seriously weaken his policy credibility, posing a risk to subsequent governance. However, under current political and economic constraints, Powell will not easily choose to raise interest rates, which is contrary to Trump's policy preferences and the will of the American people. However, under the constraint of not raising interest rates, how to convey clear anti-inflation signals to the market will be an important test for him. The bank believes that the best choice for the Federal Reserve at the moment is to abandon guidance for interest rate cuts, use this as a signal, and avoid falling behind the curve. In addition, if market concerns about inflation further manifest, it is not ruled out that Powell may use strengthened expectations of balance sheet reduction as an alternative to raising interest rates. The benefit of doing so is to strengthen signals of inflation suppression while maintaining consistency in policy statements. In any case, faced with inflation, the market needs a Federal Reserve that is "less accommodative." This means that the likelihood of marginal tightening of US dollar liquidity is higher, and assets driven solely by liquidity may continue to be under pressure.