The U.S. Federal Reserve announced on the 18th that it would lower the target range of the federal funds rate by 50 basis points to a level between 4.75% and 5.00%. This is the first interest rate cut by the Federal Reserve since March 2020, and it also marks a shift from a monetary policy tightening cycle to an easing cycle.
The Federal Reserve ended its two-day monetary policy meeting on the same day. The Federal Open Market Committee, the decision-making body of the Federal Reserve, issued a statement on the 18th after the meeting, saying that the committee has "greater confidence" that the inflation rate can sustainably move towards the 2% target, and believes that the risks of achieving the two major goals of full employment and price stability are roughly balanced.
At a press conference held after the meeting, Federal Reserve Chairman Powell called the 50 basis point rate cut a "powerful action" and said that the Federal Open Market Committee did not think that the rate cut was slow, but rather that it was a timely move.
First rate cut in 4 years
In order to ease domestic inflation, the Federal Reserve raised interest rates 11 times in a row from March 2022 to July 2023, with a cumulative increase of 525 basis points.
Over the past year, the Federal Reserve has maintained the target range for the federal funds rate between 5.25% and 5.5%, the highest level in 23 years.
In recent months, as the inflation situation in the United States has further eased and the job market has shown signs of weakness, the Federal Reserve has faced pressure to change its policy. In August, Federal Reserve Chairman Powell said that the "time has come" to adjust monetary policy, almost clearly indicating to the market that the Federal Reserve will cut interest rates at the monetary policy meeting held on September 17-18.
Why cut interest rates?
Inflation eases, job market softens
Analysts believe that historically, unless faced with a major economic crisis, the Fed rarely cuts interest rates by 50 basis points when starting a new rate cut cycle. The Fed’s rate cut, which was more aggressive than expected, may be aimed at achieving a “soft landing” for the economy and offsetting the risk of a “stalling” in economic activity.
Recent data shows that the U.S. Consumer Price Index (CPI) rose by 2.5% year-on-year in August, falling to a new low since February 2021, close to the Federal Reserve’s 2% inflation target. Powell noted that the personal consumption expenditures price index had fallen to 2.2% in August from a high of around 7%, indicating that inflation had "easing significantly." The latest economic outlook released by the Federal Reserve that day showed that Fed officials’ median forecast for the personal consumption expenditures price index at the end of this year fell to 2.3%, down from 2.6% in June.
As inflation fell, the U.S. job market showed some signs of weakness. Powell said that the average monthly job growth in the past three months was 116,000, which was significantly lower than the level earlier this year. At the same time, the unemployment rate rose to 4.2%. According to the latest economic outlook, the median forecast of the unemployment rate by the Federal Reserve officials at the end of this year is 4.4%, higher than 4.0% in June, which means that the labor market situation is not as good as previously expected.
Personal consumption expenditure growth has slowed down, manufacturing activity has been in a contraction range for many consecutive months, the labor market has continued to be weak, and the number of new jobs in the private and non-agricultural sectors has declined sharply month by month. The above factors have caused some investors to worry that the US economy is approaching a recession.
In addition, economic outlook expectations also show that 19 members of the Federal Open Market Committee expect the Fed to further cut interest rates before the end of this year, of which 9 expect a 50 basis point cut and 7 expect a 25 basis point cut.
What impact will the interest rate cut have?
Affected by the Federal Reserve's interest rate cut, the U.S. stock market fluctuated and closed down on the 18th.
As of the close of the day, the Dow Jones Industrial Average fell 103.08 points from the previous trading day to close at 41,503.10, a drop of 0.25%; the S&P 500 fell 16.32 points to close at 5,618.26, a drop of 0.29%; and the Nasdaq Composite fell 54.76 points to close at 17,573.30, a drop of 0.31%.
The Federal Reserve began to raise interest rates aggressively in March 2022, raising the target interest rate range from zero to 0.25% to 5.25% to 5.5% in a short period of time. Looking back on this round of interest rate hikes, some American experts believe that the Fed's approach has not only had a huge impact on the international financial market, but has also failed to alleviate the cost of living crisis for the American people.
Saurabh Gupta, Senior Fellow at the Center for Chinese and American Studies: The U.S. economy has received a lot of fiscal stimulus, but the federal government is still facing a huge budget deficit at this stage. The cost of living crisis still exists. Although the inflation rate has declined, the cumulative price level over the past four or five years is still quite high compared to the wage level. Due to the federal government's poor management of the interest rate cycle, this cost of living crisis is still intensifying. Long-term interest rates are still quite high, commodity pricing is also high, and the cost of corporate borrowing, mortgages, etc. is also high. Many families are negatively affected by high prices. People's lives are not as good as the economic data makes them look.
What does this rate cut mean?
On September 13th local time, the Office of the United States Trade Representative announced that starting from September 27th, tariffs will be imposed on Chinese-made electric vehicles, solar cells, key minerals, steel, aluminum, masks, and shore container cranes.
Historically, almost every round of interest rate cuts has been accompanied by a recession in the U.S. economy.
Image source: Yuyuan Tantian
In this chart of the U.S. Effective Federal Funds Rate, the red shaded areas are the times when the National Bureau of Economic Research has determined that the U.S. is in recession.
It can be seen that from the oil crisis in the 1970s, the savings and loan crisis in the 1980s, the Internet bubble at the turn of the century, to the global financial crisis in 2008 and the global COVID-19 pandemic in 2019, every time the Federal Reserve cut interest rates significantly, it coincided with the shadow range of recession.
That’s why rate cuts are sometimes seen as a “signal of economic weakness” — an attempt by the Fed to stimulate economic recovery through easier monetary policy.
Global monetary policies gradually turn to easing
What impact will it have on China?
In addition to the Federal Reserve, several central banks have recently announced interest rate cuts, and global monetary policies have gradually turned to easing.
In early August, the Bank of England cut its benchmark interest rate by 25 basis points to 5%; on September 4, the Bank of Canada announced a 25 basis point cut in its benchmark interest rate to 4.25%; the European Central Bank announced a second rate cut on September 12; on September 18, the Indonesian central bank cut its key interest rate by 25 basis points to 6%, which was expected to be 6.25%.
What will be the subsequent monetary policy of the People’s Bank of China?
On September 5, Zou Lan, Director of the Monetary Policy Department of the People's Bank of China, said that policy adjustments such as lowering the reserve requirement ratio and interest rates still need to observe economic trends. The policy effect of lowering the reserve requirement ratio at the beginning of the year is still continuing to show. At present, the average statutory deposit reserve ratio of financial institutions is about 7%, which still has some room. Affected by factors such as the speed of bank deposits diversion to asset management products and the extent of the narrowing of bank net interest margins, there are still certain constraints on the further decline of deposit and loan interest rates.
In terms of the RMB exchange rate, the trend of the RMB exchange rate has not shown obvious regularity in the past interest rate cut cycles of the Federal Reserve. Recently, the expectation of the Federal Reserve's interest rate cut has increased, the interest rate gap between China and the United States has narrowed, and the reverse liquidation of Japanese yen carry trades has increased the willingness of enterprises to settle foreign exchange, and the RMB has appreciated significantly. The research team of Minsheng Bank said that after the Federal Reserve's interest rate cut "boots" land, the pressure on the depreciation of the RMB will be further reduced.
In this regard, Yang Delong, chief economist of Qianhai Kaiyuan Fund, said that the Fed's entry into the interest rate cut cycle will first affect the implementation of a relatively loose monetary policy by the People's Bank of China, which may boost economic growth through a variety of means such as lowering the reverse repurchase rate, the interest rate of existing mortgage loans, and lowering the deposit reserve ratio. On the other hand, the renminbi has recently experienced a round of appreciation, and the pressure on the central bank to maintain exchange rate stability has been greatly reduced, which also lays the foundation for the central bank to adopt more monetary policy tools. The renminbi's entry into the appreciation range will attract foreign capital to return to renminbi assets, which is good news for the current weak A-share market and is conducive to promoting a slight rebound in the A-share market.
"For our country, adhering to the general tone of monetary policy and giving priority to supporting domestic economic development has been adhered to for many years," he said.