Federal Reserve Chairman Powell stated in his speech on November 4th that the current performance of the US economy is good and there is no signal of a rush to cut interest rates. This stance has attracted widespread attention from investors and has been interpreted as hawkish. Afterwards, the market increased its bet on the Federal Reserve keeping interest rates unchanged at its December meeting, with an expected probability of 38%, compared to 14% a month ago. Powell's speech also propelled the US dollar to rise for seven consecutive weeks, with the 10-year Treasury yield hitting 4.5% and US stocks falling from high levels.
What exactly did Powell say? Firstly, he pointed out that "the US economy has not sent any signals of the need to urgently lower interest rates, and the better economic conditions allow us to make cautious decisions [1]." He also mentioned the uncertainty of the neutral interest rate level, "as the central bank approaches a reasonable neutral level range, we may need to slow down our pace to increase our chances of making the right decisions
We believe Powell wants to send a signal to the market that the Federal Reserve intends to slow down interest rate cuts in the context of a strong economy. Powell has expressed his views after the November Federal Reserve FOMC meeting, and the release of a more hawkish signal at this time is due to marginal changes in several aspects. Firstly, the latest released CPI and PPI inflation data for October did not further decline, indicating that although inflation is still slowing down, the road is winding. Secondly, the initial unemployment claims data released since November continue to improve, indicating that the previous non farm weakness was mainly due to the impact of hurricanes and strikes, and the overall labor market remains stable. Thirdly, the latest released retail sales for October increased by 0.4% month on month, slightly exceeding the market's expectation of 0.3%. In addition, the growth rate for September was significantly revised up from the previous 0.4% to 0.8%, indicating that consumer demand remains strong. Taking all these factors into consideration, we believe that Powell wants to send a signal that the Federal Reserve needs to consider slowing down the pace of interest rate cuts.
Although there are still several weeks left until the next Federal Reserve meeting, we believe Powell's remarks provide some forward guidance that policymakers have begun to consider lowering the dot matrix. Against the backdrop of increased uncertainty in the downward path of inflation, stable employment, and sustained positive economic data, the Federal Reserve's confidence in the economy's ability to successfully avoid recession has been further strengthened compared to its September interest rate meeting. Therefore, policymakers are unwilling to "act too quickly" and hope to lower the pace towards the endpoint interest rate. Considering the new dot matrix to be released at the December interest rate meeting, we believe that Powell's statement at this time is more of a "precautionary shot" for the market, foreshadowing that the Federal Reserve may not continue to cut interest rates at every meeting next year, and the final interest rate level may not be as low as it was judged in September. We predict that the number of interest rate cuts shown in the new dot plot for 2025 will decrease from the previous 4 to 2, corresponding to the endpoint interest rate of 3.75% -4.0%. This will be consistent with our annual outlook report's judgment on the magnitude of interest rate cuts, "Overseas Macro Outlook 2025: From Soft Landing to New Equilibrium".
In terms of pace, the Federal Reserve's interest rate cuts will also enter the "slow lane". Our previous judgment was to cut interest rates by 25 basis points in December this year, and by 25 basis points each in the first and second quarters of 2025, and then stop cutting interest rates. We maintain this judgment that the pace of interest rate cuts will slow down after entering 2025. Why continue to cut interest rates? Firstly, because there are currently no signs of inflation rebounding. According to the October CPI report, inflation did not further decline mainly due to the rebound in second-hand car prices, while rental prices remained sticky. The former is more like a short-term fluctuation, as the forward-looking indicator Manheim Used Car Index shows that the latest trading prices have once again turned downward. The stickiness of the latter is within our expectations, as we previously reported that rent inflation in the coming months may remain at a level of 0.3% -0.4%. In addition, one of the indicators that the Federal Reserve is most concerned about - the supercore of non rental core services - saw a month on month growth rate drop to 0.3%, indicating that the prices of major services are also relatively moderate. We believe that these data have not changed the trajectory of the slowdown in US inflation, and there is still great uncertainty about when Trump's tariffs and tax cuts will be implemented. The Federal Reserve will not abandon its interest rate cut plan based on expectations (please refer to the report "Election Results Do Not Affect Federal Reserve Interest Rate cuts").
Secondly, the recent "Trump deal" has shown characteristics of a strong US dollar, high interest rates, and weak commodities, which may actually be beneficial for curbing inflation. Since the end of the US presidential election, the market has been heavily trading the potential impact of Trump's policies since taking office, with the most obvious being the strengthening of the US dollar exchange rate and the rise in US bond yields. However, the appreciation of the local currency exchange rate is beneficial for alleviating input inflation, while the rise in interest rates helps to suppress demand and prevent economic overheating. In addition, the market is concerned that Trump's tariffs will hinder global economic recovery, which will suppress commodity demand and put pressure on prices. In the past few weeks, commodity prices such as crude oil and copper have experienced varying degrees of decline, which has also helped to reduce short-term inflation risks.
Overall, we maintain our previous judgment that the Federal Reserve will continue to cut interest rates, but the pace of rate cuts will slow down, gradually transitioning from cutting rates at every meeting to once every quarter, until the policy rate is lowered to between 3.75% and 4%. This level is about 150 basis points higher than the neutral interest rate before the pandemic, indicating that US interest rates will remain high for the long term, and low interest rates are not the color of this era.
Chart: Inflation will enter the 'last mile' of decline in 2025
Source: Wind, China International Capital Corporation Research Department Chart: We expect the Federal Reserve to cut interest rates at a higher endpoint than before the pandemic
Source: Wind, Bloomberg, Research Department of CICC