To cut interest rates or not to cut interest rates, what is behind the tangled Fed? Recommended reading: ★★★★
It is relatively rare for last week's CPI data and interest rate decision results to appear at the same time, but the answers they brought are also incredible. The Federal Reserve allowed the market to witness "its own" lack of calmness and entanglement. Why do I say that?
"Weak employment will cause us to cut interest rates earlier," "But strong employment will not necessarily cause us to postpone rate cuts," and "It is the inflation data that determines whether I will postpone rate cuts." These are statements made by the Federal Reserve before.
The reason why the market ignores the expectation that the Fed will only cut interest rates once in 2024 is because the Fed’s statement is logically confusing, neither calm nor rational.
Let's interpret the logic of the Fed's statement:
1. If the topic of discussion is the factors that lead to early interest rate cuts, then early interest rate cuts belong to the type of policy stimulus, which is the target of market expectations and the stimulating policy news that everyone is looking forward to.
2. Postponing the interest rate cut is a contractionary policy under the current circumstances, and it is also an outcome and policy that the market does not want to see. Under the current high interest rate norm, not to mention raising interest rates, postponing the interest rate cut is enough to make the market nervous enough, this is a fact.
3. Reference indicators: employment rate, inflation CPI,
The employment rate is a leading indicator and usually changes before the economy changes. To put it bluntly, everyone first needs to participate in employment and work in order to get paid. Only by participating in employment can enterprises start work and production, and ultimately generate labor, and then participate in life consumption, which will then have an impact on the economy.
Inflation CPI is a lagging indicator. It changes only after the economy has changed. When humans participate in work production, receive income, enterprises produce and sell, etc., and all this is completed and consumption is eliminated, the CPI inflation situation can be reflected.
So we compare employment and inflation, where employment can be seen as the cause and inflation as the effect.
4. "If the employment rate is not good, the interest rate will be lowered in advance" and "If the inflation rate is too high, the interest rate cut will be postponed." This is the original intention of the Federal Reserve.
Therefore, according to the results described above, we can see that the Fed is using leading indicators to promote stimulating easing policies, while using lagging indicators to promote contractionary tightening policy expectations.
The employment rate (leading indicator) drives early interest rate cuts, while the inflation rate (lagging indicator) delays interest rate cuts.
5. Through the description of "4", we can conclude that the Federal Reserve is more proactive about stimulus policies because it uses leading indicators to promote them, but is more cautious about contractionary policies because it uses lagging indicators to mark them.
6. So according to the original statement of the Fed, the Fed hopes to implement stimulus policies early, that is, lower interest rates, and then carefully mark the contraction policy through the lagging indicator CPI.
Judging from the Fed's statements on economic policy, the Fed hopes to release stimulus policies as soon as possible. The reason for this is that the Fed is the head of the family and knows that food, clothing, housing and transportation are expensive and that the actual situation of the US economy may not be very good. If we interpret the Fed from this perspective, we can actually see a negative Fed, not a positive one, let alone a neutral one.
7. Before this dot plot, the view released by the Federal Reserve was "fear", and the source of fear came from concerns about future economic recession and the failure of stimulus policies.
8. A strange logic problem arises. If the Fed previously released negative and worried sentiments, and also agreed with the market's expectation of a rate cut, why did it change its tone in this dot plot and directly tell the market that there will only be one rate cut, and is currently postponing the rate cut? This is illogical, unless the Fed itself is "helpless"
9. In fact, the independence of the Federal Reserve and whether it is affected by certain orders have always been a hotly discussed topic, but no one has substantive evidence. However, at present, the changes in the dot plot after last week's interest rate meeting result make it difficult for people not to doubt whether the Federal Reserve has "independence".
10. According to economic logic, after the interest rate hike cycle, the US inflation has slowly declined, the economy has not declined, the job market has only recently declined, the financial market is stable, etc., then under these conditions, the interest rate should have been cut long ago, but it has not been cut for various reasons. Why? This makes the policy irrational, and it is inevitable that people wonder whether the Fed's fear comes from the future after the interest rate cut?
11. We need to note that while not lowering interest rates, the United States is issuing treasury bonds and printing money crazily. Of course, the money printing here is not to directly increase the currency nor to be completed through QE, but through the central bank's purchase of treasury bonds in the secondary market. This kind of action is called monetary fiscal deficit, which is to provide funds for government spending. The beneficiary of this way of printing money is the government, and the entire financial market is nervous. Of course, although the Federal Reserve has begun to slow down the reduction of the balance sheet and gradually slow down the QT action, it is still not very effective, and Powell did not mention or deliberately avoided the QT question in his speech this time. To put it bluntly, there is no further recommendation for the government to "print money".
By interpreting the Fed’s previous and current logic, combined with its actual performance, we can actually understand why the market has begun to “distrust” the Fed and even take contradictory actions (U.S. stocks continued to rise after expectations of rate cuts were postponed).
Of course, we still cannot understand whether this is intentional by the Fed to send a "false signal" to the market and the world, or whether the Fed is really "helpless". All we can do is wait patiently, make bold guesses, and carefully verify.
Figure 1: The Fed’s interest rate decision-making process
Figure 2: Comparison of factors affecting the Fed’s interest rate decision
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