CICC: Fed Cuts Rates Sharply for Soft Landing
The Federal Reserve cut interest rates by 50 basis points at its September meeting, with the monetary policy statement emphasizing the goal of maximum employment.
The Fed's actions indicate that its reaction function has shifted entirely from focusing on inflation to focusing on employment.
Officials have a low tolerance for rising unemployment rates and do not want to jeopardize the favorable outlook for a "soft landing" due to excessive tightening.
Looking ahead, we believe that the Fed is likely to maintain a "dovish" stance until the labor market stabilizes.
The rate cut will further increase the possibility of a soft landing in the short term in the United States, but the policy mix of "loose fiscal and easy monetary" may also increase the risk of inflation in the medium term.
The background of this meeting is the slowdown of inflation in the United States in the past two months, coupled with signs of weakening in the labor market.
The market wants to know how the Fed will respond to these marginal changes, what is its reaction function?
Before the meeting, the market had fully anticipated this rate cut, and the uncertainty lies in whether the rate cut is 25 or 50 basis points.
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Looking at the interest rate decision, the Fed has taken a more aggressive rate cut of 50 basis points, which is more aggressive than we expected.
The monetary policy statement pointed out that recent inflation data has given policymakers more confidence in achieving the 2% inflation target.
At the same time, with the rise in the unemployment rate, the Fed also emphasized its commitment to the goal of maximum employment (The Committee is strongly committed to supporting maximum employment...)[1].
The Fed's actions indicate that its reaction function has shifted entirely from focusing on inflation to focusing on employment.
Fed Chairman Powell said at the Jackson Hole meeting in August, "I do not welcome further cooling of employment data"[2].
After that, the non-farm data released in August was mixed, with the unemployment rate falling from July, but the increase in non-farm employment continued to slow down.
It is clear that Powell believes this change has triggered the situation he spoke of, so he hopes to fulfill his promise at this meeting and promote a 50 basis point rate cut.
Although Powell denied victory over inflation at the press conference, he now seems to focus only on employment.
Powell said he hopes the unemployment rate will remain at the current level and will not continue to rise[3].
Fed officials also predicted that the unemployment rate will rise by 0.2 percentage points by the end of this year, to 4.4%.
In 2025 and 2026, the unemployment rate will remain around 4.4%.
We believe this is a signal that the Fed has a low tolerance for rising unemployment rates, and officials do not want to take risks and damage the favorable outlook for a "soft landing".
Based on Powell's statement, we believe that any unemployment rate above 4.4% in the future may trigger more rate cuts.
This also indicates that the Fed will maintain a "dovish" stance until the labor market data stabilizes.
According to the latest dot plot, among the 19 officials, 10 people predict that there will be at least two more rate cuts before the end of this year, and another 7 people predict that there will be only one rate cut, and 2 people predict that there will be no more rate cuts[4].
This indicates that most officials tend to continue to cut interest rates before the end of the year to ensure that the unemployment rate is controlled within the full employment range below 4.4%.
However, this 50 basis point rate cut is not a consensus among everyone.
Among the 12 voting officials, 11 voted in favor, and Governor Bowman voted against, she is more inclined to cut interest rates by 25 basis points[5].
This is also the first time since 2005 that a Fed governor has voted against.
Another subtle point is that after the non-farm data was released in August, Fed officials did not clearly release a signal to cut interest rates by 50 basis points until last week's "silence period" began, there was news that the Fed was considering a larger rate cut.
This indicates that policymakers have also hesitated on the issue of whether to cut interest rates by 25 or 50 basis points.
Looking ahead, due to the Fed's larger interest rate cut, the possibility of a soft landing in the short term will further increase.
Historical soft landings are usually accompanied by interest rate cuts, because moderate adjustments in monetary policy after large-scale tightening help to avoid excessive tightening.
This time, due to the improvement of supply factors and the short-term controllable risk of inflation, the Fed's interest rate cut will support the expansion of demand, and the economic growth in the United States may continue to maintain a high speed, thereby increasing the probability of a soft landing.
Fed officials in the latest forecast lowered their forecast for inflation and kept their forecast for economic growth unchanged, also indicating their confidence in a soft landing.
However, in the medium term, the United States' policy mix of "loose fiscal and easy monetary" may increase the risk of inflation.
The latest data from the U.S. Treasury shows that the fiscal deficit increased to $380.1 billion in August, an increase of $136.3 billion from the deficit in the previous month, and an increase of $469.3 billion from the deficit in the same period last year.
Looking at the year-on-year change, the increase in the fiscal deficit in August is the highest level in the past three years.
In addition, the cumulative fiscal deficit from January to August 2024 has reached $139 billion, an increase of $284 billion from the same period last year, an increase of 26%.
These data indicate that this year's fiscal policy has not only not tightened, but has continued to expand.
Expansionary fiscal policy itself has the effect of boosting the economy, coupled with the Fed's current larger interest rate cuts to reduce the unemployment rate, which may lead to the economy returning to a "no landing" state in the medium term.
At that time, if the supply factors no longer improve, the rebound in demand may also push up inflation.
Today, after the Fed's interest rate meeting, the yield on U.S. Treasury bonds did not fall but rose, and the yield curve steepened, which may also reflect the market's concern about the long-term inflation risks that the Fed's aggressive interest rate cuts may bring.
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