While Wall Street investment banks are debating whether the Federal Reserve will start cutting interest rates in March or June, the strong rebound in the US Consumer Price Index (CPI) and Producer Price Index (PPI) in January has poured cold water on market expectations for rate cuts.
Both data exceeded market expectations, mercilessly breaking the optimistic prediction that inflation has been controlled. Since the Federal Reserve began its interest rate hike cycle in March 2022, it has raised interest rates 11 times, with a cumulative increase of 525 basis points. Currently, the target range for the federal funds rate is maintained at 5.25% -5.5%. Federal Reserve officials also believe that policy interest rates may have reached their peak this cycle, but they have not ruled out the possibility of further rate hikes and seem more inclined to act cautiously, hoping to see more evidence of steady downward inflation. Most officials are concerned about premature interest rate cuts and deep-rooted price pressures.
Of course, the Federal Reserve has already opened a crack in the door to interest rate cuts. Federal Reserve Chairman Powell stated in an interview in early February that the Federal Reserve is expected to implement three interest rate cuts this year, each of which is about 25 basis points, and is expected to start cutting rates as early as May. Previously, the market had been betting that the Federal Reserve would cut interest rates six times starting from March, and it was expected that the rate cut would exceed 150 basis points in 2024.
In theory, if the Federal Reserve maintains high interest rates for a long time, it will bring many risks. In fact, the significant interest rate hike by the Federal Reserve has not hindered the recovery of the US economy, and the economy and labor market seem to remain resilient. The unemployment rate is at a historic low, with the latest increase of 353000 non farm employment, the largest increase in a year. In addition, the path of inflation's return is fraught with twists and turns. In this process, if the Federal Reserve releases a signal of interest rate cuts too early, it may stimulate a significant increase in financial asset prices, a rebound in corporate investment, and an increase in consumption, leading to more sticky inflation or a resurgence, making it more difficult to achieve the 2% inflation target. This is also the main reason why the Federal Reserve is not in a hurry to cut interest rates.
However, there is a time lag in monetary policy. It is generally believed that the time lag of monetary policy is about one to one and a half years. Therefore, the lagging impact of the current high interest rates from the Federal Reserve on the economy remains to be seen. As the effects of high interest rates gradually become apparent, there is uncertainty about whether the US economy can achieve a soft landing. The financial situation may experience non-linear deterioration, which in turn may have a greater negative impact on the economy. Although the entire market seems to be looking forward to the Fed's interest rate cut, as the 2024 election approaches, adjusting monetary policy has become a challenge for Powell.
It is worth noting that the impact of the Federal Reserve's interest rate cuts based on different economic situations on the global economy will vary.
The Federal Reserve's interest rate cut in the context of a soft landing in the US economy may be like walking on thin ice and maintaining extreme caution, leaving the market exhausted from dealing with the "wind and grass" brought by various data. This is positive for the global economy, as the US economy has not experienced a recession. From a trade perspective, exports from other countries to the US are expected to remain in an ideal state; The return of capital to emerging markets and developing countries will reduce their financing costs and increase their financing possibilities in the international market. At the same time, the appreciation of their domestic currency against the US dollar may also help alleviate the US dollar debt pressure faced by these countries.
If there is a hard landing in the economy, the Federal Reserve may cut interest rates as aggressively as before, but it will have a huge negative impact on the global economy. In the event of a technical recession in the US economy, global demand will inevitably be weak. International capital flows to the US treasury bond bond market for the sake of hedging demand, which will lead to short-term depletion of global dollar liquidity. This will have a serious impact on emerging markets and developing countries, and the market will also have sharp fluctuations.