The turning point signals for global markets and Federal Reserve policy seem to have emerged.
On the evening of November 14th (Tuesday) Beijing time, futures traders began to heavily bet that the Federal Reserve would abandon the December rate hike and significantly advance the expected first rate cut in 2024. Previously, the US Bureau of Labor Statistics announced a significant drop in CPI in October. Affected by this, major stock indices in Europe and America closed sharply higher on Tuesday, while the US dollar index plummeted significantly. The 10-year US Treasury yield plummeted nearly 0.2 percentage points to below 4.5%, marking the largest daily decline since the bankruptcy of Silicon Valley Bank in March
Data shows that core inflation in the United States increased by 4% year-on-year in October, hitting a new low in over two years. Although this is still far above the Fed's 2% target, Reuters reported that this downward trend may give Fed policymakers more confidence that their policies have reached a sufficiently tight level. Many traders and analysts also agree with this view, for example, Brian Jacobsen, Chief Economist of Annex Wealth Management, bluntly stated, "We can say goodbye to the era of interest rate hikes.
However, the one-year inflation expectation for the University of Michigan for October, announced last week, unexpectedly rebounded to 4.4% (expected 4%), indicating the difficulty of the Federal Reserve in controlling inflation in the final stage. In response, Federal Reserve Vice Chairman Jefferson stated at a meeting in Zurich, Switzerland that monetary policy makers may need to take other measures to control market inflation expectations in the absence of clarity on how long inflation may last.
The first interest rate cut is expected to be significantly advanced to May next year
The Wall Street Journal reported that with the release of October inflation data, core inflation has slowed for five consecutive months and is approaching the necessary conditions that Federal Reserve officials have long stated are no longer necessary to raise interest rates.
Michael Feroli, an economist at JPMorgan Chase, stated in a report to clients after the October CPI report that the data further reduced the likelihood of the Federal Reserve raising interest rates in December. He pointed out that these data may also affect the predictions released by the Federal Reserve at the next FOMC meeting. Feroli stated that due to data showing that inflation in the fourth quarter was lower than the level predicted by the Federal Reserve at the September FOMC meeting, and the current unemployment rate has slightly increased, "they may find it difficult to justify offsetting the dove stance with more hawkish positions
Analysts say the latest CPI data reduces the likelihood of the Federal Reserve resuming interest rate hikes early next year. The focus of officials at the December meeting may not be on whether to raise interest rates, but on whether and how to modify the guidelines in the post meeting policy statement to reflect the latest developments in inflation and subsequent policy paths.
At the September interest rate meeting, FOMC officials had expected another rate hike, but now, another rate hike is clearly not within market expectations. Most economists also believe that the most aggressive rate hike cycle of the Federal Reserve since former Chairman Paul Volcker took office in the 1980s has come to an end.
According to the "Federal Reserve Observation" tool of Chishang Exchange, the probability of the Federal Reserve further raising interest rates by 25 basis points to the 5.50% to 5.75% range next month after the October CPI data is released is only 5.5%, significantly lower than the 28% before the data was released.
At the same time, based on the interest rate pricing of Chishang Exchange, traders now believe that the Federal Reserve will start cutting interest rates as early as its meeting in early May 2024, earlier than previously expected in July 2024. In addition, the futures market currently expects the Federal Reserve to cut interest rates four times by 25 basis points next year, which means that the federal funds rate in the United States will be a full percentage point lower than the current level by the end of next year, to 4.25% to 5.50%.
Although the market has responded very positively to the October CPI data, it should be noted that the November CPI and non farm employment data will also be digested before the Federal Reserve's FOMC meeting in mid next month. Last month, the cooling of the US non farm employment market exceeded market expectations, and the unemployment rate slightly increased to 3.9%. Wage growth also fell to a new low in two and a half years.
However, Ian Shepherdson, Chief Economist at Pantheon Macroeconomics, stated in a commentary that "only the extremely poor CPI in November and a significant rebound in non farm employment could trigger another short-term interest rate hike
Focus on controlling inflation expectations
The reporter of the Daily Economic News noted that the US inflation soared to a 40 year high in the summer of 2022 due to the "water release" of the Federal Reserve at the beginning of the COVID-19 in 2020, but at present, many factors have played a restraining role in inflation. For example, the supply chain situation has significantly improved, car prices are falling, and high mortgage rates have cooled the US housing market.
In the current situation of abundant employment opportunities and continuous shortage of labor, the demand for workers by enterprises is still high, but wage growth has slowed down, which has alleviated people's concerns about the uncontrolled spiral of wage price increases.
Both the US CPI and core CPI continued to cool in October
Although the year-on-year increase in US CPI has significantly decreased from its peak of 9.1% in June 2022, the trend of "disinflation" in recent months has stagnated against the backdrop of relatively tight labor markets and strong economy.
Michael Pearce, Chief American Economist at the Oxford Institute of Economics, also pointed out in a comment email to reporters at the Daily Economic News that, Overall, the October CPI data should prompt Federal Reserve policymakers to abandon further interest rate hikes. However, the process of anti inflation still has some way to go, and the subsequent weakening of service sector inflation depends on the continuous cooling of the labor market. Therefore, the Federal Reserve still needs a long time to start considering interest rate cuts
Currently, American consumers clearly have higher expectations for future inflation. Last week, data released by the University of Michigan showed that consumers had an initial inflation expectation of 4.4% for the next year, with an expectation of 4%. They also had an initial inflation expectation of 3.2% for the next 5-10 years, setting a new high since 2011. Analysis indicates that the unexpected rebound in inflation expectations indicates the difficulty of the Federal Reserve in controlling inflation in the final stage.
In response, prior to the release of October inflation data on Tuesday evening Beijing time, the current Vice Chairman of the Federal Reserve, Jefferson, also stated at a meeting in Zurich, Switzerland that monetary policy makers may need to take other measures to control market inflation expectations in the absence of clarity on how long inflation may last. However, he did not describe his preference for the outlook for the US economy or specific policy paths.
Jefferson emphasized that central bank governors must consider uncertainty when formulating policies. Economic literature proposes two distinct approaches: one suggests gradualism in the face of uncertainty, and the other calls for stronger monetary policies than usual.
A case of long-term concern for central banks is the persistence of inflation. In this case, both methods outlined in the literature tend to adopt stronger policies to prevent the possibility of inflation inertia embedding into inflation expectations, "Jefferson said.
In fact, officials, including Federal Reserve Chairman Powell, have been reluctant to declare a "victory" over inflation. They point out that in the past, they believed that price pressures were indeed weakening, but prices turned around and went up. At the same time, some officials are also cautious, as even if inflation continues to decline, it may stagnate above the Federal Reserve's 2% target.
The Wall Street Journal reported that whether the Federal Reserve can sustain the current sustained decline in inflation in the United States depends to some extent on the US economy's response to the Fed's aggressive rate hikes over the past year and a half in the coming year. Strong consumer spending has helped strengthen the resilience of the US economy this year, but economists predict that as the lagging impact of the Federal Reserve's interest rate hike continues to permeate the economy, consumers will reduce spending, including a slowdown in expected employment and wage growth.
