21st Century Economic Report reporter Wu Bin from Shanghai reported that at the end of this interest rate hike cycle, the fog of the Federal Reserve's monetary policy has become increasingly dense.
On October 11th local time, the Federal Reserve released the minutes of the Federal Open Market Committee (FOMC) meeting from September 19th to 20th, and officials were divided on whether another rate hike was needed this year. Under the influence of highly uncertain economic trends in the United States, unpredictable financial market conditions, potential oil price shocks, and strikes, Federal Reserve officials took a cautious stance at the September policy meeting while debating whether further interest rate hikes were needed.
The wording and stance of this meeting minutes are relatively neutral. Most attending officials believe that raising interest rates again at future meetings may be appropriate, with the aim of cooling demand and bringing inflation closer to the target of 2% in the next two years. Some officials also believe that further rate hikes may not be necessary. In the matrix forecast released in September, 12 out of 19 officials expect another interest rate hike this year.
Overall, caution has become the tone of future Federal Reserve monetary policy, and all participants believe that the next step should be "caution". Interest rate decisions will depend on economic data performance and consider "risk balance". Although the market expects a greater likelihood that the Federal Reserve will not raise interest rates for the rest of this year, in a data dependent model, it is still uncertain whether the Fed's rate hike cycle will end, and neither the market nor the Federal Reserve can predict the future.
Divergent opinions abound
At a time of uncertainty about the economic and inflation prospects, it is not surprising that there are disagreements within the Federal Reserve.
Wang Xinjie, Chief Investment Strategist at Standard Chartered China's Wealth Management Department, told 21st Century Economic Report reporters that behind the disagreement over whether to raise interest rates in the future, it is actually the different views within the Federal Reserve on inflation and economic growth. Officials who support further interest rate hikes believe that the US economy still shows resilience and can withstand the impact of further interest rate hikes. Given this consideration, it is even more necessary to combat inflation, especially when nominal inflation is disrupted by energy prices.
On the other hand, officials who support the suspension of interest rate hikes believe that such a tightening policy is already sufficient to limit the economy and requires longer time to analyze its impact, and there is no need to continue raising interest rates before that. Firstly, the US economy is not without immediate worries, but it is not without foresight. The reduction of excess savings and a tightening environment may have a longer-term negative impact. Secondly, although input inflation causes disturbances, it is more of a short-term impact, and a decrease in core inflation as expected indicates that endogenous inflation is cooling down. Therefore, suspending interest rate hikes but allowing interest rates to remain high for a longer period of time is a more appropriate choice.
Cao Hongyu, a researcher at the Bank of China Research Institute, told 21st Century Economic Report reporters that the minutes of the September Federal Reserve's interest rate meeting showed internal differences, reflecting the increasing cognitive differences among officials about the current tightening situation in the US market. This further indicates that the Federal Reserve's interest rate hike policy is at a critical point. However, overall, both the minutes of the meeting and the previous and subsequent statements indicate that whether there will be another rate hike by the Federal Reserve in the future depends on data performance, and the Federal Reserve will make a cautious decision.
In addition to internal disagreements within the Federal Reserve, there are also disagreements between market expectations and the Federal Reserve. The market expects the Federal Reserve not to raise interest rates again this year, but most Federal Reserve officials still expect another rate hike in the future.
Regarding this, Wang Xinjie analyzed that the market's policy expectations for the Federal Reserve highly depend on economic events and data. Prior to the release of the meeting minutes, the market believed that the probability of interest rate hikes in November and December was 30% and 40%, respectively. But after the release of the meeting minutes, the market interpretation was biased towards doves, with the probability of interest rate hikes dropping to less than 10% and 20% in November and December, respectively. Compared to the market, the Federal Reserve's lattice chart and caliber have always been more cautious. The lattice chart has little guiding significance for future interest rate hikes, and future economic data changes will have a significant impact on the caliber of Federal Reserve officials and market expectations. On the other hand, market expectations and the general direction of the Federal Reserve's monetary policy are the same, with high interest rates expected to persist for a longer period of time. The market expects the Federal Reserve to start cutting interest rates as early as the third quarter of 2024.
The inflation problem is difficult to solve in the short term
At the end of the Federal Reserve's interest rate hike cycle, recent US inflation data has once again shown unfavorable signs.
According to data released by the US Department of Labor on the 11th, the PPI in September increased by 0.5% month on month and 2.2% year-on-year, both exceeding market expectations. The year-on-year growth rate of 2.2% is the highest level since May this year, and since the low point of 0.2% in June, PPI data has rebounded for three consecutive months. Excluding volatile food and energy, the core PPI in September increased by 2.7% year-on-year, which is also higher than the expected 2.3% and 2.2% in August.
According to Wang Xinjie's analysis, the US September PPI exceeded expectations, with the most important influencing factor coming from terminal demand for energy and trade services. After removing energy and food, the core PPI also exceeded expectations and previous values. The main reason for the recent rise in PPI is the supply side pressure caused by the geopolitical crisis. Generally speaking, the supply side impact of the geopolitical crisis is relatively short-term and prone to market noise. From a longer perspective, there is still pressure on the demand side, and the probability of PPI pressure becoming a long-term problem is relatively low.
Cao Hongyu also believes that the significant increase in global oil prices since September is the main reason for the unexpected increase in US PPI. Affected by energy prices, the cooling of inflation in the United States has been hindered in the past two months. Considering factors such as the possibility of OPEC+extending the production reduction agreement and the sudden escalation of the Israeli-Palestinian conflict, global energy prices will face greater upward pressure in the future, and the inflation trend in the United States may face new variables.
The current battle against inflation by the Federal Reserve is far from winning. Boris Schlossberg, macro strategist at BK Asset Management, stated that as the situation in the Middle East heats up, energy prices may once again become a factor of price volatility. For the Federal Reserve, it is far from the moment to declare victory.
Correspondingly, the minutes of the Federal Reserve meeting indicate that Federal Reserve staff expect inflation to continue a slow downward trend, and the year-on-year increase in the PCE price index will return to around 3.5% by the end of the year, before it can fall back to nearly 2% by 2026.
It should be noted that the attitude of Federal Reserve officials has undergone subtle changes since the September meeting. Jerry Chen, a senior analyst at Jiasheng Group, told 21st Century Business Herald reporters that although the minutes of the Federal Reserve meeting showed that most officials supported further interest rate hikes in September, some officials' attitudes seem to have changed recently, believing that high US bond yields have played a disguised role in raising interest rates, and therefore calling on the Federal Reserve to suspend interest rate hikes.
The shift in expectations for the Federal Reserve's monetary policy is also reflected in market performance. Cao Hongyu stated that at the September interest rate meeting, most officials proposed another rate hike as appropriate. However, there has been a change in the stance of Federal Reserve officials recently. Several Federal Reserve officials have spoken out and released "dove like" comments, leading to a rebound in market risk sentiment. This week, US bond yields have sharply declined, and the three major US stock indices have closed higher for several consecutive days.
Monetary policy may still be tight
Given the high degree of uncertainty surrounding inflation and the economic situation, future Federal Reserve monetary policy will still rely on economic data.
In Wang Xinjie's view, although there are disagreements within the Federal Reserve, there is still a certain consensus that "the future policy direction should depend on economic data". Future monetary policy will balance inflation and economic data. If economic data remains resilient and inflation remains sticky, continuing to tighten is still one of the options. On the contrary, inflation is lower than expected, economic data is declining, and stopping interest rate hikes or even early interest rate cuts will be put on the agenda.
The minutes of the meeting show that the Federal Reserve has found that risks have become more balanced. Participants generally stated that while the monetary policy stance remains restrictive, the risks faced by the committee in achieving policy objectives will become more bidirectional, and it is important to balance the risks of excessive and insufficient tightening.
Where will the Federal Reserve's monetary policy go in the future? Wang Xinjie believes that in the short term, there is a possibility of nominal inflation being impacted by energy prices, and there is also pressure on core inflation. However, in the long run, core inflation is unlikely to change its downward trend. The short-term economic growth of the United States still shows resilience, especially the rebound in manufacturing investment. However, the volatility of the job market has begun to increase. In the future, under the pressure of a tightening environment and the depletion of excess savings, there are still long-term concerns about the US economy. Overall, the necessity for the Federal Reserve to raise interest rates in the short term is decreasing, and it may maintain high interest rates for a longer period of time, with interest rate cuts starting in the third quarter of 2024.
Despite recent signs of easing in the hawkish attitude of the Federal Reserve, monetary policy may still be tight for some time to come. All participants agreed that until the Federal Reserve is confident that "inflation will continue to fall to 2%," interest rates should be kept in a position to constrain the economy for a period of time.
There is currently no possibility of the Federal Reserve cutting interest rates in the short term. Cao Hongyu stated that Federal Reserve officials have a consensus on the fact that "inflation may take longer to fall back to the 2% target", which means that the Federal Reserve has a consensus on maintaining higher interest rates for a longer time, and the corresponding rate reduction decision is likely to be further delayed.
And in the future, the probability of scale reduction will last longer than interest rate hikes. The minutes of the meeting showed that the process of continuous scale reduction is an important component of the Federal Reserve's achievement of macroeconomic goals. Several participants pointed out that even if the Federal Reserve starts to cut interest rates in the future, scale reduction "may still continue for a period of time".