Aggressive Rate Cuts Aid Soft Landing

The Federal Reserve's aggressive rate cut of 50 basis points this month has kicked off a rate-cutting cycle, meeting the market's "expectations."

However, from an economic resilience and historical comparison perspective, the necessity for a 50 basis point rate cut is actually not high.

This indicates: First, this decision still cannot rule out the political disturbances of an election year.

Second, it is to prevent a fake stock market crash from the perspective of financial stability.

Third, the Fed's determination to protect the job market is strong, unwilling to pay the price of "recession" in exchange for the return of the inflation target, and unwilling to lag behind the curve in the context of rising unemployment rates; after the aggressive rate cut, the resilience of the US economy and inflation will be further enhanced, and the "soft landing" within the year will also constrain the room for subsequent rate cuts to a certain extent.

It is expected that the Fed will cut rates by 100 basis points within the year, with 25 basis points cuts in November and December, in line with the current dot plot guidance; but the room for rate cuts in 2025 may not reach 100 basis points as shown in the current dot plot.

The Fed's aggressive rate cut also leaves room for China's domestic monetary policy, with the pressure on the RMB-US dollar exchange rate significantly reduced, and the external pressure on the prices of Chinese stocks and bonds further alleviated.

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The aggressive start of the rate-cutting cycle, the future path of rate cuts dynamically changing, and the decision-making framework becoming more complex in terms of interest rate ranges, the Fed's rate cut of 50 basis points is in line with the market pricing before the meeting, exceeding our previous expectation of 25 basis points; the federal funds target rate is reduced to the range of 4.75%-5.00%.

In terms of the balance sheet reduction policy, the Fed's balance sheet reduction speed for holding government bonds remains at 25 billion US dollars; the balance sheet reduction speed for holding MBS remains at 35 billion US dollars per month.

Regarding the guidance for rate cuts, the median forecast of this month's dot plot gives a 100 basis point rate cut space within the year, but from the distribution of the dot plot, there is still a significant divergence among Fed officials, and there are also many officials who believe that only a 75 basis point rate cut is needed within the year.

The median forecast for the end of 2025 is at 3.25%-3.5%, implying a total rate cut space of about 200 basis points for this round.

For the future policy path, Powell has given a highly flexible guidance: First, in the post-meeting Q&A, Powell pointed out that "no policy path is predetermined, and decisions will be made on a meeting-by-meeting basis."

Second, Powell pointed out that "the speed of rate cuts can be flexibly adjusted, and it can continue to be fast or slow, and 50 basis points should not be taken as a fixed rate cut step."

Third, in the interest rate statement, in addition to continuing to indicate that the current policy is walking a tightrope between inflation and employment, it also specifically pointed out that it will take into account the development of financial markets and international situations, which also means that the Fed's future policy framework will become more complex.

Although the 50 basis point rate cut this month meets the market's expectations, Powell's highly flexible position does not give a "guarantee" for the future path of rate cuts, and various assets have fluctuated widely during the meeting.

During the meeting: the Nasdaq and Dow Jones first rose and then fell, the 10-year US Treasury rate and the US dollar index first fell and then rose, and gold first rose and then fell.

The unemployment rate was revised upwards to exceed the threshold, and the inflation forecast was lowered but still relatively high, and the Fed's policy is walking a tightrope.

In terms of economic forecasts, the GDP expectation for the year was slightly revised downwards.

The Fed slightly revised down the GDP expectation for 2024 to 2.0% (June forecast 2.1%).

In terms of employment, the unemployment rate forecast was significantly revised upwards to 4.4% (previous forecast 4.0%), which is also the core of the Fed's decision-making adjustment compared to the June dot plot, but Powell also pointed out in the post-meeting Q&A that immigration is an important factor affecting the current rise in the unemployment rate.

The neutral unemployment rate remains at 4.2%, but we believe that after considering the complex impact of immigration, this indicator may be adjusted in the future.

In terms of inflation, the Fed revised down the forecast for 2024 PCE and core PCE to 2.3% and 2.6%, respectively, with previous values of 2.6% and 2.8%.

The unemployment rate forecast is significantly revised upwards, and the continuous return of inflation to the 2% target is also in line with the Fed's current tightrope policy stance, and the difficulty of balancing the two major policy goals has increased.

In terms of the neutral interest rate, the Fed has once again revised up the neutral interest rate expectation to 2.9% after March and June, in line with our previous judgment.

Further verification that in the case of possible increases in inflation and deficit centers, the neutral interest rate may have significantly moved up.

The expectation of the neutral interest rate may be further revised upwards to above 3%.

It is expected that the rate cut of 100 basis points within the year will be as shown in the dot plot, but the room for rate cuts in this round may not reach 200 basis points.

On the one hand, the US economy still has resilience (see below), and on the other hand, we also compared the history of the Fed starting the easing cycle with a 50 basis point rate cut in our previous report "The Fed almost 'officially announced' the rate cut in September", and the current economic growth or asset price callback pressure is significantly less than the corresponding stage, and the necessity to start with a 50 basis point rate cut is not high.

However, in this context, the Fed still started this cycle with a big step of 50 basis points, indicating: First, this decision still cannot rule out the political disturbances of an election year.

After the press conference, there were also questions from reporters "whether political factors were included in the decision-making consideration", although Powell denied it, it also shows that behind the Fed's big step rate cut, this question also exists in the US market.

Second, from the perspective of financial stability, it is to prevent a fake stock market crash.

Currently, the assets of US residents are highly concentrated in the US stock market, and a decline in the US stock market may cause a negative feedback in asset prices, impacting the balance sheets of residents, and then amplifying the originally "fake fall" economic downturn risks, leading to the self-realization of negative expectations.

We pointed out in our previous report "Will the Fed cut interest rates in advance?

": If the US stock market continues to decline in the future, we believe that the Fed may cut interest rates in advance to deal with financial stability shocks; if it cuts interest rates in advance, the amount is "most likely" to reach 50 basis points or more.

Third, the Fed's determination to protect the job market is strong, and it is unwilling to pay the price of "recession" in exchange for the return of the inflation target.

Powell also pointed out in the post-meeting Q&A that it will "strive for a soft landing".

In this context, the Fed started the rate-cutting cycle with a big step of 50 basis points, choosing to prioritize the protection of the job market in the context of a continuous rise in the unemployment rate, and then making decisions based on changes in inflation and employment data.

The pre-pricing of the financial market this time also put pressure on the Fed.

If the easing is not as expected, the US stock market may adjust significantly and increase the risk of negative feedback.

We believe that after the big step rate cut, the resilience of the US economy and inflation will be further enhanced, which will also constrain the room for subsequent rate cuts to a certain extent.

In this context, we believe that the Fed will cut rates by 100 basis points within the year, with 25 basis points cuts in November and December, in line with the current dot plot guidance; but the room for rate cuts in 2025 may not reach 100 basis points as shown in the current dot plot.

The US economy still has resilience, and the big step rate cut will help the US economy achieve a soft landing.

First, on the consumption side, the service industry consumption still has resilience, with a year-on-year growth rate of about 3% since the second half of the year, and the resilience of residents' balance sheets and the job market is an important support; on the consumption of goods, the replacement cycle of durable goods has started as scheduled, with a year-on-year growth rate that has gradually increased from below zero to above 3% since the beginning of the year, and it is expected that the replacement cycle will continue in the future.

Second, on the investment side, looking at inventory investment, the US is currently in the active restocking phase where both inventory and sales year-on-year growth rates are rising; looking at capital expenditure, the core highlight is that corporate equipment investment is taking over the upward repair of factory investment.

In this context, we believe that the risk of the US economy losing speed and "recession" is extremely limited, and after the Fed starts the rate-cutting cycle with a big step of 50 basis points, it will also help the US economy achieve a soft landing.

The Atlanta Fed's GDPnow model has also recently revised the Q3 year-on-year rate forecast to 3% (revised multiple times since September).

The structure of the US stock market may switch; the US dollar and US Treasury rates are gradually bottoming out and rebounding.

In terms of the US dollar, we believe that after this round of global resonance enters the rate-cutting cycle (except for Japan), the US dollar will maintain high resilience.

The reason is that the fiscal space of the United States is relatively significant compared to major economies, especially Europe, and the use of fiscal tools can also make monetary easing play a higher multiplier effect.

After the rate cut is implemented, the US economy will still maintain a relative advantage, thereby helping the US dollar maintain resilience.

In terms of US Treasury bonds, considering that the pricing of the interest rate cut space within the year has been relatively sufficient, and whether it is Trump or Harris's policies in 2025 may increase the US reflation pressure and constrain the space for further widening of the current rate-cutting cycle expectations, we believe that it is difficult for the 10-year US Treasury rate to fall significantly further.

In terms of gold, after the US dollar and US Treasury rates stabilize, the resistance for gold to rise further in the short term increases; in the medium to long term, the global geopolitical instability expectations & the potential reflation pressure in the United States will still benefit the long-term trend of gold.

In terms of the US stock market, it is expected that the short term will still maintain a high volatility rate, but with the joint support of economic soft landing and monetary easing, the downside risk is limited.

In the process of fluctuation, the prosperity may gradually switch from the previous technology giants to the "US dividend" (oil and gas sector, public utilities, etc.)

and Russell 2000 and other small-cap stocks.

The Fed's rate cut this time also leaves room for China's domestic monetary policy, with the pressure on the RMB-US dollar exchange rate significantly reduced, and the external pressure on the prices of Chinese stocks and bonds further alleviated.