July 2-Interpretation of Powell’s speech: Adjusting the expectation strategy from inflation to deflation!

The Internet was disconnected at night. I finally waited for the Internet to come back to sort out the content of Powell's speech tonight and make my own interpretation:

First of all, let's make sure that the content of Powell's speech tonight is dovish. In fact, there is no need to guess too much about the reasons, just look at the US stock market. As mentioned before, the Federal Reserve is using expectation management to control the rhythm of the market, especially the US stock market.

Last Friday, the US stock market closed down. As the consensus on interest rate cuts is not clear, the trend of the US stock market in the second half of the year may mean a risk of a decline. At the same time, the second quarter earnings season of the US stock market is approaching from July to August. Due to the bull market in the US stock market in the first half of the year, the market expectations are too high, which will bring certain pressure to the second quarter earnings report and easily lead to the risk of a decline in the US stock market. Therefore, it is necessary for Powell to release appropriate dovish remarks to boost the US stock market through his speech.

It should be noted that at the same time as Powell's speech, U.S. stocks opened with a decline, and then began to rebound after the speech.

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Summary of Powell's speech:

1. The opening directly releases positive economic sentiment. The labor market remains strong, the economy maintains steady growth (neither overheated nor too slow), and the downward trend in inflation has gradually shown signs of recovery.
PS: The gradual recovery of the downward trend in inflation means that the high inflation environment has slowly returned to a more stable and controllable state. It also means that the overall price level is slowing down its growth pace.

2. Recognize the current work on inflation control and believe that considerable progress has been made in this regard.

3. Then he changed the subject and said that more confidence is needed before lowering interest rates, which means that slowing inflation is no longer a necessary reason for lowering interest rates. In other words, even if inflation slows down or accelerates, the Fed still needs more other factors as reasons to cut interest rates.

4. Talking about the labor market, although the unemployment rate hit 4% in May, it is still within the Fed's expectations. The Fed will not react unless it is unexpectedly weak. In other words, if the unemployment rate grows slowly, it is still not a necessary factor for lowering interest rates. The Fed will not react unless the unemployment rate deteriorates continuously in the short term.

5. Emphasize that the Fed clearly knows when to cut interest rates, and the Fed also understands the risks of cutting interest rates too early or too late. The subtext is that cutting interest rates is a proactive behavior of the Fed in the future, rather than a passive behavior driven by certain economic data.

6. Inflation is expected to drop to around 2% next year or the year after, and the Fed’s current policy has limitations, but it is appropriate for inflation control and economic regulation. The Fed’s inflation target is 2% next year or the year after, so whether inflation data continues to decline or rebounds in the short term, it will not shake the Fed’s expectations. Unless inflation rebounds continuously or reaches 2% ahead of schedule, it will not change the Fed’s current policy.

7. For policy regulation, that is, interest rate cuts, the potential risk that the Fed is worried about is that if interest rates are cut too quickly, inflation will rebound and get out of control, and if interest rates are cut too slowly, the labor market will unexpectedly weaken. Therefore, the Fed knows where the risk points are and when to cut interest rates. Therefore, Powell said that the Fed has its own judgment ability and sufficient decision-making time on whether to cut interest rates in September.

8. In the future, the Fed’s interest rate will not drop to a very low level, nor will it return to a zero interest rate environment. This sets the tone for future interest rate cuts.

9. Talking about AI is a major change. Although the Federal Reserve did not use generative AI, the subtext is that the Federal Reserve may have also used traditional AI technology (those who are interested can learn about the difference between generative AI and traditional AI). This just confirms the boost to US stocks mentioned at the beginning of the article. This sentence recognizes AI and also brings more illusions to the market (the Federal Reserve may have already applied AI technology)

10. No comments on the dot plot indicate that the frequency and benchmark of interest rate cuts given by the dot plot are not recognized or opposed, which again leaves more room for imagination in the market. (The probability of a rate cut in September has reached 70%)

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In fact, Powell's entire speech released economic stability and recognition of inflation. Just looking at it now, it doesn't feel like a dovish stance. The reason why the market feels dovish is that Powell mentioned a key word in his speech - deflation.

Deflation: It refers to a continuous decline in the price level of an economy (prices of goods and services). This is a possible situation under a monetary tightening policy. Prices continue to fall, and the purchasing power of money increases. At the same time, it will lead to a slowdown in economic activity and an increase in debt burden.

Powell mentioned that the United States has returned to austerity, and Powell's view means that the era of inflation in the US economy is coming to an end. The current economy is no longer described as effective control or effective reduction of inflation, but as moving towards deflation. This indicates that the US economy has currently escaped the threat of inflation. At the same time, once it is confirmed that it has entered deflation, interest rate cuts and even money printing will come randomly, because if liquidity does not increase, the economy may go into recession.

Therefore, the market is excited about Powell's view that the United States is heading towards deflation and future interest rate changes. Although Powell's specific reason for deflation may be to emphasize the recent strength of the US dollar index, and we may all know the reasons for the strength of the US dollar index, Powell decisively believes that the rise of the US dollar index and the decline in the prices of US goods and services are the path to deflation. At the same time, because of this concept of deflation and tightening, the price of 10-year US Treasury bonds has been pushed up in the short term.

So we don’t care whether the purchasing power of the US dollar has really increased, but the expectations released by Powell tonight are good. Once the pace of deflation is driven, or deflation is really likely to occur, this will increase the pace of interest rate cuts. However, in the short term, this positive effect is more about allowing the existing liquidity in the market to flow to US stocks and bonds, and the crypto market feels a bit drained.

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