The Fed begins "rate cuts," global capital markets cross the turning point - Huxiu.com#
The Fed begins "rate cuts," global capital markets cross the turning point#
This article discusses the impact of the Fed's rate cuts on global capital markets. By analyzing the changes in US bond yields and expectations management, the article points out that the Fed has indeed cut interest rates. At the same time, the article also mentions the importance of key economic data and future focus.
• The Fed's rate cuts have triggered a turning point in global capital markets.
• Powell's speech expressed expectations management for rate cuts.
• The release of key economic data has a significant impact on market expectations.
Why "rate cuts"?
In the article "Expectation-guided monetary system and the Fed's expectation management framework," we spent a lot of space discussing the core of the US monetary policy system - expectation guidance, and emphasized that the two-year US bond yield is the real interest rate, and the federal funds rate is not the real interest rate.
Generally speaking, the dot plot will be announced at the end-of-quarter interest rate meetings, while other interest rate meetings will not announce it. Therefore, the dot plot of the September interest rate meeting is still the current expectation framework: 1) one more rate hike; 2) two rate cuts next year. The central point of the two-year US bond yield given by this benchmark is 5.12%.
However, after this interest rate meeting, the two-year US bond yield fell sharply to around 4.95%, which means that the market has adjusted its expectations based on Powell's speech and key data.
Based on the new expectations, we can infer the implied dot plot: 1) there will still be one rate hike in the next three interest rate meetings; 2) three rate cuts next year.
Therefore, from the perspective of changes in the implied dot plot, the Fed has indeed cut interest rates, from 5.12% to 4.96%, a decrease of about 16 basis points.
I. Changes in the supply and demand curve of money
The changes in the supply and demand curve of money corresponding to this operation are shown in the following figure:
On the one hand, the demand curve has shifted from D1 to D2, which, under the condition of unchanged two-year US bond yields, has led to a contraction of money supply from Q1 to Q2.
Specifically, it is reflected in the rapid rise of term spreads:
On the other hand, in this interest rate meeting, the Fed guided expectations and caused the two-year US bond yield to fall, alleviating the bad situation. The overall liquidity situation has improved significantly, and the ten-year US bond yield has fallen to around 4.70%.
According to the expectation-guided monetary policy framework, even if the economy further contracts in the future, the term spread will not rise rapidly, and may even fall. Here, we need to pay attention to the changes in term spreads in an environment with inflation constraints.
II. Powell's speech from the perspective of expectation management
Grasping the bull's nose of expectation management, it is not difficult to understand Powell's speech. His purpose includes two aspects: 1) guiding the decline of the two-year US bond yield; 2) but also not wanting the two-year US bond yield to decline too much.
Therefore, from a technical point of view, Powell will definitely not give up the possibility of raising the federal funds rate in the future, otherwise, it would be an expectation collapse.
As shown in the above figure, poor expectation management will lead to the complete loss of control over the latter half of the expected path, like a detached rope, lying on the ground, causing a sharp contraction of its internal area.
Based on this principle, from the perspective of expectation management techniques, Powell's remarks must be filled with hawkish rhetoric, but also leave a gap for doves:
On interest rate policy: The Fed may need to further raise interest rates. The view that it would be difficult to resume rate hikes after a pause is incorrect. The Fed is currently not considering rate cuts and has not discussed rate cuts. Powell stated that the Fed has made great progress in this rate hike cycle and is close to the end of the cycle. Within the estimated range of the neutral interest rate, reservations must be made about the estimate of the neutral interest rate.
On the US economy: Economic growth far exceeds expectations. The Fed did not include a recession in its forecasts for this meeting, and the economy has shown unexpectedly strong resilience. Evidence that GDP is higher than potential levels can prove that rate hikes are reasonable; GDP growth is strong but expected to slow down. The Fed's policy stance is restrictive, which puts downward pressure on the US economy.
On inflation: Resolutely committed to restoring the inflation rate to the 2% target. A few months of good inflation data is just the beginning. Powell does not believe that the Fed has reached the position of inflation falling to 2%. Progress will continue to be made in fighting high inflation, but the process will be bumpy. The Fed is on track to make more progress in fighting high inflation. Inflation expectations are "in good shape" and face the risk of rising inflation expectations. Current inflation risks are more two-sided.
On the job market: Nominal wage growth shows signs of moderation. Wage growth has slowed significantly in the past 18 months. Labor demand still exceeds available supply. Improvements in the supply side, such as immigration, are helping the US economy.
On the bond market: Financial conditions have tightened significantly. Pay attention to the rise in long-term bond yields, which may have an impact on policy. Expectations of rate hikes have not led to an increase in long-term bond yields. It is not yet clear to what extent this corresponds to rate hikes.
On financial stability: The US banking system is "quite resilient." There is no reason to believe that the Fed's rate hikes are changing the situation in the banking industry.
On geopolitics: The global geopolitical situation is definitely high. The FOMC is tracking the economic impact of geopolitical developments. Oil prices have not yet significantly reflected the recent Israeli-Palestinian conflict. It is unclear whether the Middle East conflict will have a significant economic impact.
On fiscal sustainability: The US government shutdown is a potential risk.
As shown in the above figure, both dovish and hawkish statements are necessary. On the one hand, increasing dovish statements will lower the center of gravity of the "rope"; on the other hand, maintaining the necessary hawkish statement paradigm to maintain the normal operation of the system, after all, we are still in a process of suppressing inflation.
Therefore, we should not overly focus on a single statement from Powell, but should look at the overall picture and consider it comprehensively.
In fact, the overall expression of Powell's "center of gravity" has indeed decreased, so the market also understands it and has lowered its expectations for rate hikes, that is, reducing its own expectations.
III. Impact on capital markets
In the article "Conditions for A-shares to enter a right market" we emphasized the importance of the two-year US bond yield. Only when the two-year US bond yield effectively breaks through downwards, can A-shares enter a right market.
Currently, the two-year US bond yield has reached around 4.93%, approaching the lower edge of the volatility range.
In addition, in the article "The extreme position of the ten-year US bond and A-shares and the turning point of global liquidity," we also discussed the theoretical conditions for the turning point of global liquidity.
When the two-year US bond yield breaks through and continues to decline, it is possible to offset the rise in term spreads caused by economic contraction, push the ten-year US bond yield to continue to decline, and form a turning point in global liquidity.
Therefore, the key point still lies with the Fed, that is, how the Fed manages expectations and gradually guides the two-year US bond yield down.
IV. Future focus
In the article "Expectation-guided monetary system and the Fed's expectation management framework," we have discussed how the Fed's expectation management framework is constructed, which includes three levels, with the degree of control over expectations increasing step by step:
Statements and dot plots of interest rate meetings;
Adjustment of key economic data.
In fact, the release of key economic data is also an important aspect of expectation management and belongs to a part of monetary policy.
Currently, in addition to changes in officials' speeches and interest rate meeting statements, there have also been significant changes in the release of key economic data, with more bad numbers being disclosed. Before the December interest rate meeting, we will still focus on key economic data, and we will see enough bad numbers before the possibility of raising the federal funds rate is eliminated.
In summary, whether from the perspective of the resolution statement or the release of key economic data, the Fed has indeed shifted, and global capital markets have crossed the turning point.
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