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What is the interest rate of the Federal Reserve? - Huxiu.com#

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What is the interest rate of the Federal Reserve?#

Expected guidance monetary system and the Federal Reserve's expected management framework. The article analyzes the operation of the Federal Reserve's expected management framework and the US monetary system, pointing out that the real interest rate is the two-year US Treasury bond rate, not the federal funds rate. The article also discusses the vulnerability of expectations and the role of key economic data in expectation management.

• The Federal Reserve's expected management framework includes official speeches, the dot plot of the interest rate meeting, and the management of key economic data.

• The vulnerability of expectations can lead to the collapse of expectations, affecting the changes in the two-year US Treasury bond rate.

• Managing key economic data is an important means to maintain expectation stability, especially when the economy enters a stagflation stage.

On October 26, 2023, the United States announced its third-quarter economic data: the initial annualized quarterly real GDP growth rate in the third quarter of the United States increased by 4.9%, expected to increase by 4.3%, and the final value of the second quarter increased by 2.1%; the revised value of the second quarter increased by 2.1%, and the initial value of the second quarter increased by 2.4%.

In response to this, American investor Cathie Wood commented:

Government statistics do not seem to reflect the weakness of the economy. Many companies have reported shocking weak revenues. UPS's package volume growth in the United States is not as good as that from 2007 to 2009. After falling for nearly two years, it fell by about 11% in the last quarter.

In fact, Elon Musk expressed similar doubts in early May this year:

Compared with the lagging data of the Federal Reserve, Musk believes that the data in his hands is the "real-time picture" reflecting the economic situation, so he has a better understanding of the current global economic situation. If the Federal Reserve continues to raise interest rates, the currently "mildly declining" economy will turn into a "severe recession".

From the perspective of the US stock market, there was a rapid rise in June and July, and Musk's doubts seemed to be wrong. However, after August, the US stock market started a rapid decline again, showing how the economy went from a "mild recession" to a "severe recession" in just five months.

Therefore, we have an important question: Does the US government's economic data necessarily reflect the true state of the economy?

This article intends to interpret this question from the perspective of how the US monetary system operates, that is, whether the US government's key data is used to reflect the real economy or other functions.

What is the interest rate of the Federal Reserve?

There has always been a popular but inconspicuous mistake in Chinese financial media: not knowing which interest rate of the Federal Reserve is.

Many people believe that the interest rate of the Federal Reserve is the federal funds rate, which is the specific entity. This is in line with the tendency of Eastern people to prefer concrete things.

However, unfortunately, the Federal Reserve's system was created by Westerners, and the real interest rate is the two-year US Treasury bond rate, which is an abstract thing, an expectation of the future path of the federal funds rate.

Obviously, there is a significant difference between the two, one is a cold entity, and the other is a variable expectation that reflects changes in people's minds.

Here is an interesting metaphor: the federal funds rate is a piece of hard brick, but we can use these bricks to build houses of different shapes. Although the house is made up of bricks, its function far exceeds that of bricks.

From this perspective, treating the federal funds rate as the "real interest rate" is a serious mistake that completely loses the essence of the US monetary system-expectation guidance.

From Entity to Expectation

The federal funds rate is a specific entity, and the two-year US Treasury bond rate is an abstract expectation. The following figure clearly shows the relationship between the two:

Behind each two-year US Treasury bond rate is not only the current federal funds rate, but also the expectation of the entire path in the future.

Currently, the two-year US Treasury bond rate is 5%, and its corresponding expected path is: 1. Raise interest rates once at the end of the year; 2. Cut interest rates three times next year.

In fact, this rate has deviated from the dot plot. According to the dot plot of the interest rate meeting in September, the two-year US Treasury bond rate should be 5.13%.

The leader and executor of expectations

From the perspective of the federal funds rate, the interest rate meeting in September did not raise interest rates.

However, from the perspective of expectations, the Federal Reserve adjusted the dot plot, postponed the timing of interest rate cuts, expanded the internal area, and pushed up the two-year US Treasury bond rate, essentially creating the effect of raising interest rates.

The capital market is the executor of expectations. They revise expectations based on their own feelings and key economic data, forming the final result-the two-year US Treasury bond rate.

As shown in the above figure, although the interest rate meeting in September provided an expectation framework: 1. Raise interest rates once at the end of the year; 2. Cut interest rates twice next year, the capital market, based on its own feelings and key economic data, revised this expectation to: 1. Raise interest rates once at the end of the year; 2. Cut interest rates three times next year.

Overall, the expectation-guided monetary system is completed by two main entities: the expectation guide and the expectation executor. The former provides the framework, and the latter provides the substance. Both are indispensable.

Vulnerability of expectations

However, expectations are not entities, they are extremely fragile, and the capital market may not comply with the guidance of the Federal Reserve. This can lead to the collapse of expectations.

As shown in the above figure, even if the federal funds rate remains high, once expectations collapse, the internal area will also shrink significantly, leading to a rapid decline in the two-year US Treasury bond rate.

In fact, there was a "expectation collapse accident" in March 2023. The trigger for this accident was the "Silicon Valley Bank incident." Investors did not believe that the Federal Reserve would maintain a hawkish attitude in the event of problems in the US financial market.

After the "expectation collapse accident," it took the Federal Reserve nearly 4 months to rebuild the collapsed house.

Measures to strengthen expectations and the Federal Reserve's expected management framework

Since the "expectation house" can collapse due to special events and key economic data, it is necessary for the US government to manage key economic data to maintain the stability of the "expectation house."

The closer it is to the second half of the interest rate hike cycle, the greater the need for this management. This is because as the economy declines, everyone's perception becomes worse, but from the perspective of curbing inflation, it is necessary to keep the two-year US Treasury bond rate high.

Therefore, managing key economic data becomes an important means to grasp market expectations.

As shown in the above figure, the authorities can adjust the data as much as possible during critical periods and try not to let "bad data" leak out. Until the critical period is over, the data can be made up.

Therefore, if we understand the core of the US monetary system-expectation management, we can naturally regard "disclosure of key economic data" as a tool for expectation management. Therefore, the following is the expected management framework of the Federal Reserve:

This framework is divided into three layers, with the degree of control over expectations decreasing step by step:

1. Official speeches;

2. The dot plot of the interest rate meeting;

3. Adjustment of key economic data.

Stagflation situation

If we include the disclosure of key economic data in the expected management framework of the Federal Reserve, then the strength of key economic data and the contraction of the real economy will not be so conflicting.

The former reflects the monetary policy intentions, and the latter reflects the actual economic situation. We are currently in a cruel stagflation stage.

As shown in the above figure, the strength of key economic data will only make the two-year US Treasury bond rate strong, but the actual economy has been contracting, so the money supply in the financial system is rapidly decreasing. This is a typical stagflation situation.

In fact, since August, the US financial market has experienced a double kill of stocks and bonds, fully reflecting the contraction of liquidity.

In addition, if the disclosure of key economic data is included in "monetary policy" as part of the money supply curve, we can understand a very strange phenomenon: when economic data is "good", the S&P 500 index falls.

In fact, "good" economic data is almost equivalent to interest rate hikes themselves because this system is built on expectations.

Conclusion

In summary, we can understand the criticisms of Cathie Wood and Elon Musk and our long-standing confusion. The key points are as follows:

1. The core of the US monetary system is expectation guidance;

2. The real interest rate is the two-year US Treasury bond rate, not the federal funds rate;

3. Maintaining expectation stability is not easy and sometimes requires special measures;

4. The Federal Reserve's expected management framework includes: a. Official speeches; b. The dot plot of the interest rate meeting; c. Management of key economic data;

5. When the economy enters a stagflation stage, managing key economic data becomes a necessary means.

In the article "Conditions for A-shares to enter a right-hand market," we discussed the necessary conditions for A-shares to enter a right-hand market: the two-year US Treasury bond rate turns downward.

This article tells us how to judge the turning point of the two-year US Treasury bond rate: the Federal Reserve starts to release "bad data."

Recently, the US authorities have started to disclose some "bad data":

1. The initial annualized quarterly core PCE price index in the third quarter of the United States increased by 2.4% month-on-month, expected to increase by 2.5%.

2. The number of initial jobless claims in the United States last week was 210,000, expected to be 208,000, and the revised value of the previous value was revised from 198,000 to 200,000.

3. The core PCE price index in the United States in September increased by 3.70% year-on-year, reaching a new low since May 2021, expected to be 3.70%, and the previous value was 3.90%.

Do not look at things in isolation. The world is a whole; do not connect widely in a fragmented way. The world is a consistent whole.

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