According to the schedule, the Federal Reserve will release its latest interest rate resolution and quarterly outlook report (SEP) at 3:00 am Beijing time on Thursday, while Federal Reserve Chairman Powell will hold a regular post meeting press conference at 3:30 am.
For investors in the global market, this Federal Reserve's year-end performance will undoubtedly be the focus of everyone. For Federal Reserve policymakers who have been struggling with high inflation for the past two years, tonight's meeting may also mark a crucial "crossroads".
Looking back, the last time the Federal Reserve raised interest rates can be traced back to July this year - raising the target range of the federal funds rate to a 22 year high of 5.25% -5.50%. This is also the 11th rate hike by the Federal Reserve in this tightening cycle. However, since then, steadily declining US inflation data and labor market indicators showing signs of cooling have not provided Federal Reserve officials with a reason to take further interest rate hikes. Many Federal Reserve officials have also shown significant wavering in their defense of interest rate hikes.
This also makes almost all market participants believe that policymakers of the Federal Open Market Committee (FOMC) are expected to hold their interest rates unchanged for the third consecutive meeting tonight.
It is evident that behind the unanimous expectation of staying calm on tonight's interest rate decision, the focus of market participants will mainly shift to the prospects of future interest rate changes by the Federal Reserve, especially next year:
Will the Federal Reserve continue to "verbally raise interest rates" - unwilling to completely rule out the possibility of rate hikes? When will the first rate cut by the Federal Reserve come next year? How many basis points will interest rates be reduced throughout the year? Will it cut interest rates as much as 4-5 times as expected by current market traders? How will Federal Reserve Chairman Powell respond to the dovish bets on current interest rates and the stock and bond markets?
All the suspense and questions in the market are expected to be answered by the Federal Reserve tonight. It is not difficult to foresee that tonight, in addition to regular monetary policy statements and Powell's speeches, the December interest rate chart, which can intuitively reflect the expected changes in interest rates of Federal Reserve officials in the coming years, will also become the core focus of people's attention on this sleepless night of discussion!
Here is our forward-looking analysis of the various aspects of tonight's Federal Reserve resolution:
What changes are worth noting in the Federal Reserve's monetary policy statement?
In the December monetary policy statement released tonight, the FOMC responsible for setting interest rates will almost certainly state that the committee has decided to maintain the target range of the federal funds rate at 5.25% -5.5%.
However, there may be some wording adjustments in the Federal Reserve's assessment of employment, inflation, housing, and overall economic growth.
For example, Bank of America believes that the committee may abandon the idea of "further tightening policies" and only emphasize efforts to reduce inflation rates to 2%. The original text of the November meeting stated that when determining the extent of further tightening policies to restore inflation rates to 2% over time, the committee will consider the cumulative tightening of monetary policy, the lagging impact of monetary policy on economic activity and inflation, as well as economic and financial progress.
Goldman Sachs, on the other hand, believes that the FOMC statement may also exclude descriptions of a tightening financial environment (November original: a tighter financial and credit environment for households and businesses may put pressure on economic activity, recruitment, and inflation), and may make adjustments to other subtle changes previously used to express interest rate hikes.
This is actually not difficult to understand. With weak data, falling inflation, and dovish statements from the Federal Reserve, financial conditions have significantly relaxed compared to the November FOMC meeting. As shown in the figure below, the breadth of the financial condition indicators compiled by Goldman Sachs has now fallen back to the level of June last year.
In the stock and bond market, the 10-year US Treasury yield reached 5% in October, but has now fallen back to around 4.25%, which is completely consistent with the level in early September. At the same time, the stock market is also soaring. The S&P 500 index has risen nearly 20% so far this year, while the Nasdaq Composite Index has risen nearly 38%.
China International Capital Corporation (CICC) pointed out that if the relaxation of financial conditions leads to another accelerated strengthening of the US economy, forming a situation of "no landing", this will be something that the Federal Reserve does not want to see.
Liz Ann Sonders, Chief Investment Strategist at Jiaxing Wealth Management, also stated, "Suspending interest rate hikes is almost certain. However, if there is any resistance to the relaxation of the financial environment in the statement or at Powell's press conference, I wouldn't be surprised. Powell will have to solve this problem."
Interest Rate Matrix: What is Everyone's Focus Tonight?
For domestic investors who stayed up late at 3am Beijing time on Thursday waiting in front of their computer desks, the wording and details of the Federal Reserve's policy statement may still be overlooked, but I believe everyone will not forget to look at a chart at the first moment of the Federal Reserve's decision - that is, the Federal Reserve's interest rate lattice chart.
If the Federal Reserve agrees with the upcoming rate cut, it will naturally be reflected in the interest rate figures predicted by Federal Reserve officials. The market focuses on the "mean point", which is the midpoint of all members' predictions for the next three years and beyond. In the previous grid chart in September, Federal Reserve officials estimated the median interest rate for next year to be 5.1%.
It can be foreseen that the latest forecast by Federal Reserve officials for interest rates at the end of next year is likely to shift downwards compared to the September chart - as the prediction at that time was based on another rate hike this year, but this is no longer happening. Based on the situation in September, the Federal Reserve believed that interest rates would be lowered to 5.1% next year - equivalent to predicting two rate cuts in 2024. But if this forecast is still maintained, it would only be equivalent to cutting interest rates once next year - which seems unlikely.
However, the extent to which the Federal Reserve's chart has shifted downwards is unlikely to catch up with the aggressive dovish bets in the current market. As we mentioned in the Telegraph Understanding yesterday, in September, even the most dovish Federal Reserve officials only expected the Fed to cut interest rates to 4.25% -4.5% next year. However, the current pricing reflected in the interest rate futures market (about 4.1%) is already lower than this.
In other words, if the current market pricing is correct, then "all" Federal Reserve officials' views on next year's interest rate cut in September will be wrong, which is clearly unlikely.
Therefore, tonight's chart will be a starting point that can easily affect the market's judgment of the extent of the Federal Reserve's hawk pigeon stance on next year's interest rate cut. Quincy Krosby, Chief Global Strategist at LPL Financial, said that tonight's chart will be very important because a large part of the previous surge in the US stock market was based on a dovish shift in market bets - believing that interest rate cuts are imminent. If Federal Reserve officials acquiesce, even if they only slightly agree with the market's views, the market will climb.
In this regard, Goldman Sachs and Wells Fargo Bank's view is that the median interest rate chart for 2024 is expected to be lowered from 5.125% in September to 4.875%, still retaining the equivalent of two rate cuts. Goldman Sachs Chief Economist Jan Hatzius said, "To get the Federal Reserve to cut interest rates quickly, a lot more needs to happen. The second half of next year is more realistic than the first half."
Sonders from Jiaxing Wealth Management also believes that the changes in the Federal Reserve's chart will not be too radical. Sonders said, "I'm not saying that this (interest rate cut) won't happen, I just think it's too early based on the data points collected so far. In the end, perhaps the bond market (about interest rate cuts) is correct, but from now until March next year, if there is no more pain coming from the economic level, the judgment of interest rate cuts may not be correct."
Dreyfus and Mellon Chief Economist and Macro Strategist, former FOMC economist Vincent Reinhart, believes that due to the Federal Reserve's repeated inaction, their interest rate forecast for 2023 is bound to be lowered. But he also believes that policymakers may suggest a smaller rate cut in 2024 to prevent the market from leading them.
CICC also expects that due to no further interest rate hikes in December this year, the median forecast for the Federal Reserve's interest rates until the end of next year may move down to 4.8% (compared to 5.1% in September). If the new grid chart shows significantly more than two interest rate cuts next year, the market may interpret it as a dovish signal.
Economic Outlook Report: How will the Federal Reserve view the current state of economic operation?
Every quarter, in addition to releasing interest rate charts, FOMC also releases their latest forecasts for numerous key economic variables, including gross domestic product (GDP), core personal consumption expenditure (PCE) price index, and unemployment rate.
In September of this year, FOMC predicted in its Economic Forecast (SEP) that US GDP growth would slow down, unemployment rates would slightly rise, and inflation would gradually return to the Federal Reserve's target level by 2026. The industry expects that these numbers may be further revised, but there should not be too much change.
Behind the recent increase in market expectations for the Federal Reserve's interest rate cut, the overall performance of US economic data is actually mixed.
The latest revised data released by the US Department of Commerce shows that in the third quarter of this year, the US Gross Domestic Product (GDP) grew at an annual rate of 5.2%, an increase of 0.3 percentage points from the initial estimate. However, GDP is ultimately just a lagging indicator, and there are always concerns in the market about the prospects of the US economy. The results of the Brown Book survey released by the Federal Reserve in November also showed that economic activity in the United States has slowed down since the previous report was released, and the economic outlook for the next 6 to 12 months has weakened.
Goldman Sachs expects that the Federal Reserve may make a slight upward correction to GDP in its latest economic outlook report, while unemployment rates and core PCE inflation will be slightly lowered.
New York Fed Chairman Williams recently predicted that the Federal Reserve's most important inflation indicator, the PCE Price Index, will drop to around 2.25% in 2024 and approach 2% in 2025. At the same time, he predicts that the economy will slow down to 1.25% next year.
Post conference press conference: Will Powell once again play the role of a "market killer"?
Since entering the interest rate week, many Wall Street professionals have been concerned about one thing in the past few weeks, which is whether Federal Reserve Chairman Powell will suppress the recent high expectations of interest rate cuts in the market. It is obvious that at 3:30 am Beijing time on Thursday, the "stage" of the global market will be handed over to Powell. Given the recent sharp fluctuations, it is not difficult to imagine how nervous the market will be as investors wait for Powell to deliver a speech.
Analysts have pointed out that Federal Reserve Chairman Powell will face a difficult balancing issue this week, which is how to maintain the flexibility of the Federal Reserve's monetary policy plan in the face of enormous pressure to disclose when and how much it plans to cut interest rates next year.
One of the challenges facing Powell is that financial markets do not believe his warning of further monetary tightening - investors believe that the world's largest economy has slowed down enough to eliminate the need for further interest rate hikes. In addition, they believe that the upcoming data will force the Federal Reserve to cut interest rates earlier than expected.
This may also be the reason why Federal Reserve officials have been reluctant to openly discuss the issue of interest rate cuts: they are concerned that the market is overly speculating on the magnitude of the cuts beyond what actual conditions allow. This excessive speculation itself will lead to a decrease in borrowing costs, making it more difficult for the Federal Reserve to ensure that economic growth is slow enough to overcome inflation.
"They (Federal Reserve officials) may have a feeling that they have already completed (interest rate hikes) unless unexpected circumstances arise, but conveying this carries risks and costs, so they must resist this idea," said Ellen Meade, a former senior advisor on the Federal Reserve Board until 2021. "Now is a delicate moment because financial conditions are very important."
Therefore, Powell is likely to repeat the same old tune at this meeting, that is, on the one hand, he is certain that inflation will continue to slow down; But announcing a "shift" in monetary policy may be too early, and the Federal Reserve will continue to act cautiously in the future.
Nick Timiraos, a well-known journalist known as the "New Federal Reserve News Agency," said that Federal Reserve officials are unlikely to seriously discuss the issue of when to cut interest rates this week, and this may continue for the next few months unless the economy becomes weaker than expected. But they also do not believe that interest rates need to be maintained indefinitely at the current level of economic growth inhibition.
Greg McBride, Chief Financial Analyst at Bankrate, believes that we have seen this situation where market expectations are ahead three or four times, and they have lost control. Powell may have to make tough statements to control investors. The Federal Reserve has raised interest rates to levels higher than earlier market expectations, so they may not cut rates as quickly as the market expected. The Federal Reserve may continue to emphasize the old saying that policies will have to remain restrictive for a period of time.
China International Capital Corporation (CICC) pointed out that Powell may continue to emphasize at some point that the Federal Reserve needs to balance two-way risks, implying that even if interest rates are not raised, policy rates will remain high for a long time, to some extent "hitting" the market's aggressive expectation of interest rate cuts. From the perspective of playing games with the market, the Federal Reserve hopes that the market will be obedient and not against it. The Federal Reserve does not want to see asset prices fluctuate greatly, let alone increase market volatility due to its actions.
It is worth mentioning that according to research firm Bespoke's statistics, during the tenure of nearly four Federal Reserve chairmen (Greenspan, Bernanke, Yellen, and Powell), US stocks performed relatively weakly on the interest rate days during Powell's tenure. Especially in the late trading stage of the US stock market, it is often hit by the impact of interest rate decisions. And whether Powell will still play the role of a market killer at the press conference tonight, let's wait and see.