How to Track the Current Monetary Policy of the Federal Reserve? - Huxiu.com#
How to Track the Current Monetary Policy of the Federal Reserve?#
This article introduces how to track the current monetary policy of the Federal Reserve, and understand the dynamics of the market through a more granular framework. From the Federal Reserve's transition from manual driving to market-driven automatic driving, to the dynamic relationship between the S&P 500 index and the two-year Treasury yield, this article helps readers understand the Federal Reserve's monetary policy and the market's reaction.
• 💡 The Federal Reserve's monetary system is divided into two states: manual driving and automatic driving. Understanding the transition between these two states is important for tracking monetary policy.
• 💡 Observing the dynamic relationship between the S&P 500 index and the two-year Treasury yield can help understand the market's reaction to monetary policy.
• 💡 Statements from Federal Reserve officials and data releases have a significant impact on market sentiment, but it is important to avoid oversimplification and misunderstanding of their meaning.
Recently, two key data points for December in the United States were released:
Non-farm payrolls increased by 216,000 in December, with a market expectation of 170,000 and a downward revision of the previous value to 173,000. The unemployment rate in December remained at 3.7%, with an expectation of 3.8%. The labor force participation rate rose to 62.5%, with a previous value of 62.8%, and the employment-population ratio synchronously decreased to 60.1%;
The unadjusted CPI in the United States increased by 3.4% year-on-year in December 2023, with an expectation of 3.2% and a previous value of 3.1%; the seasonally adjusted CPI increased by 0.3% month-on-month, with an expectation of 0.2% and a previous value of 0.1%. The unadjusted core CPI in the United States increased by 3.9% year-on-year in December 2023, with an expectation of 3.8% and a previous value of 4%; the core CPI increased by 0.3% month-on-month, with an expectation of 0.3% and a previous value of 0.3%.
Both the employment data and inflation data exceeded market expectations, sparking discussions about U.S. monetary policy.
In some of these discussions, there is a serious bug, which is too low granularity. They hope to simplify U.S. monetary policy into easily understandable labels, such as cutting interest rates or not, recession or not, high or low inflation.
From the perspective of information dissemination, this simplification is beneficial; however, from the perspective of exploring the truth, this rough simplification only takes us further away from the truth.
This article will introduce a higher granularity framework to help everyone track the Federal Reserve's monetary policy.
I. The Basic States of U.S. Monetary Policy
The U.S. monetary system is an expectation-guided monetary system, with the Federal Reserve as the guide and the capital market as the follower.
Therefore, this system has two basic states: 1. The Federal Reserve takes control of monetary policy, which we call manual driving; 2. The Federal Reserve delegates power to the capital market, and the capital market autonomously regulates the money supply curve, which we call automatic driving.
In the article "How to Understand the Differences Between A-shares and U.S. Stocks from an Institutional Perspective," we discussed that allowing the capital market to autonomously adjust the money supply curve is a huge advantage of the U.S. capital market.
From this perspective, we can understand the significance of the December 2023 interest rate meeting: the Federal Reserve completely delegates power to the capital market, and the U.S. monetary policy transitions from manual driving to automatic driving.
As shown in the above figure, after the significant transition, the two-year Treasury yield declined significantly. This is not a reflection of the market's strong expectation of interest rate cuts, but a normal reaction to the state transition.
However, recently, with the better-than-expected employment data and inflation data, the two-year Treasury yield has been fluctuating.
So, what is the market worried about? Is it worried that the expectation of interest rate cuts will be disappointed? No, it is worried that the Federal Reserve will intervene again.
Therefore, after the key data was released, officials began to make statements:
2023 was a year of outstanding performance in reducing inflation; the Federal Reserve is still firmly on the comfortable path and making progress on inflation issues; inflation will be the main factor determining when and to what extent interest rates will be lowered.
The improvement in inflation conditions is still quite limited and mainly concentrated in commodities; I hope to see concrete evidence that inflation is moving towards the target. The December CPI data roughly met expectations; it was reiterated that the Federal Reserve will not pre-judge whether it will cut interest rates in March and will closely monitor PCE data for 1 to 3 months.
Today's inflation data has not changed my view, it shows that the work of the Federal Reserve is not yet complete. It is predicted that inflation will continue to decline this year, but it will not reach the 2% inflation target. Policy adjustments are needed to achieve a soft landing. It is too early to cut interest rates in March this year, and more evidence of inflation decline is needed. When we see sustained inflation decline, the Federal Reserve will discuss the issue of interest rate cuts.
If your thoughts are still lingering on labels such as interest rate cuts or not, inflation or not, recession or not, then you simply cannot understand what they are saying.
In fact, their true meaning is:
The market has been doing well recently;
Please continue to work hard;
We don't require reaching 2% this year, it's enough for the inflation rate to continue to decline.
After taking this reassurance pill, market anxiety quickly subsided.
As a result, we witnessed a strange scene: December inflation data exceeded expectations, but the two-year Treasury yield declined.
Previously, the market was worried about not performing well and being criticized, so the two-year Treasury yield had been deviating from the benchmark scenario of the December dot plot. After receiving affirmation from officials, everyone finally felt at ease. As a result, the two-year Treasury yield quickly fell below 4.31%.
II. Benefits of Automatic Driving
To understand the benefits of automatic driving, we need to first look at the drawbacks of manual driving - lag.
Powell suffered a big loss shortly after taking office, as the time of manual driving was too long and accidentally caused a crash in the U.S. stock market, resulting in a hard landing.
That hard landing made Powell embarrassed, so this time they learned their lesson and handed over the power of automatic driving to the market early on.
The market itself judges the position of the demand curve through the S&P 500 index and adjusts the level of the two-year Treasury yield based on the rise and fall of the U.S. stock market.
During the market's automatic driving phase, the dynamic relationship between the two-year Treasury yield and the S&P 500 index is crucial. They will converge with each other: when the S&P 500 index declines, the two-year Treasury yield will also decline; when the S&P 500 index rises, the two-year Treasury yield will also rise. This process is very delicate and is also the expertise of the capital market.
Therefore, when the market observes a significant decline in the S&P 500 index, it can't wait to bring down the two-year Treasury yield.
With this framework, we can easily determine the general asset allocation strategy. When both the demand curve and the supply curve expand significantly, the order of preference for assets is: U.S. stocks > two-year Treasury yield > ten-year Treasury yield.
So, when should we adjust the strategy? When we observe a decline in the two-year Treasury yield and a sideways movement in U.S. stocks. This means that the expansion of the demand curve is once again hindered. The order of asset preference changes to: ten-year Treasury yield > two-year Treasury yield > U.S. stocks.
In summary, we have obtained a higher granularity observation framework, which is based on the following two points:
The Federal Reserve formulates major policies, including but not limited to dot plots and inflation thresholds;
The market is in automatic driving mode, and the milestones to observe include but are not limited to stock market performance and economic data.
So, what does this framework mean for the domestic capital market?
As shown in the above figure, from December last year to now, the growth rate of domestic demand has just completed a downgrade, transitioning from a high-growth trajectory to a low-growth trajectory. The decline in the ten-year Treasury yield and the decline in the Shanghai and Shenzhen 300 Index captured this trajectory transition.
From the perspective of the domestic capital market, we hope that the "downgrade trend will end." In that case, can this low-growth trajectory remain synchronized with the current trajectory in the United States? As long as there are no adverse changes in domestic monetary policy, the domestic capital market will also benefit from the mechanism of the U.S. capital market's automatic driving.
In this stage, A-shares and U.S. stocks will end their long-term asynchrony and return to synchronization.
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