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The Federal Reserve seems to be about to start a new round of expectation management!

According to the latest news from Reuters, the Federal Reserve may delete the description of "high inflation" at next week's policy meeting. Analysts believe that if this is true, it will be the strongest signal so far that the central bank plans to cut interest rates as early as September and start the easing phase of its monetary policy cycle. Investors now believe that this is almost certain. Last night, U.S. stocks also rebounded sharply as a result.

Meanwhile, Esther George, former president of the Federal Reserve Bank of Kansas City, said the Fed is beginning to see the signals of rate cuts they have been looking for. Richard Clarida, who served as vice chairman of the Federal Reserve from 2018 to 2022, said that with falling inflation and a cooling labor market, three rate cuts this year are "definitely possible."

However, shortly before that, Fed Chairman Jay Powell and his colleagues said they needed solid evidence that inflation, which had hovered at a four-decade high, was falling back toward the Fed’s 2% target. Until then, the Federal Open Market Committee will lack the confidence needed to start lowering interest rates. President Trump, who is expected to be re-elected, also said last week that he hoped the Fed would not cut interest rates until after the November election.

Rumors about the Federal Reserve

This morning, there are two major rumors about the Federal Reserve circulating in the market: one is that the Federal Reserve will delete the description of "high inflation" in the next monetary meeting; the other is that former senior executives of the Federal Reserve keep coming out to leak that interest rates may be cut.

In September 2021, after inflation exceeded the Fed's 2% target for three consecutive months, Fed staff and policymakers changed their passive attitude toward inflation and began to describe inflation as "elevated." The description of elevated inflation was only made after the personal consumption expenditures (PCE) price index used by the Fed to set its inflation target rose above 4% in May, June and July of that year. Although the PCE price index has now fallen to 2.6% and appears to be still falling, the policy statement of the Federal Open Market Committee (FOMC), which is responsible for setting interest rates, still retains this description.

The Fed may finally remove the description at its policy meeting next week. If so, it would be the strongest signal yet that the central bank plans to cut interest rates as early as September and launch the easing phase of its monetary policy cycle, which investors currently believe is almost certain. However, there is also a view that the adjustment of the description of inflation from high to more moderate words may also lead the Fed to revise another key sentence in the current policy statement: no rate cut will be made until officials are "more confident that inflation will continue to move toward 2%."

In addition, Richard Clarida, who served as vice chairman of the U.S. central bank from 2018 to 2022, said the Fed could cut interest rates three times this year as inflation falls and the labor market cools. Clarida, now global economic adviser to asset management giant Pimco, said in an interview in Hong Kong that further improvements in U.S. inflation data and rising unemployment will affect the Fed's decision. He said Pimco predicts two rate cuts and "the possibility of a third rate cut does exist."

"A lot of people are waiting for the Fed to cut interest rates. About 5% of U.S. money market funds have“If we cut rates, it’s going to be a big deal,” said Clarida, whose firm also believes the first rate cut could come in September.

Esther George, former president of the Federal Reserve Bank of Kansas City, also said the Fed is starting to see the signals they have been looking for for a rate cut.

Traders expect the Federal Reserve to almost certainly cut interest rates at its September meeting, according to the CME Group’s FedWatch tool, which predicts the path of interest rates based on federal funds futures trading data.

Has the management of interest rate cut expectations begun?

As inflation falls, the market's expectations for rate cuts are growing stronger. But judging from the Fed's previous attitude, it is still necessary to wait. So, do the signals released in the past 24 hours mean that the management of rate cut expectations has quietly begun?

Forgoing policy meetings starting in July would allow officials to collect more quality data, a threshold Powell set at a congressional hearing earlier this month that would be met if Wall Street forecasts of further deflation come true. Between the July and September policy meetings, officials will receive two inflation and employment reports and a slew of updates on the health of the consumer and housing market.

Having more solid evidence is crucial to calming some officials who remain skeptical that the situation is safe, especially given an unexpected burst of inflation earlier this year. “They’ve been lied to before, and credibility matters,” said Diane Swonk, chief economist for the U.S. at KPMG.

Julia Coronado, a former Fed economist and current director of macroeconomic policy outlook, said the Fed acts like an "ocean liner," meaning it typically avoids sudden policy shifts except in crises. Coronado expects a "noticeable" change in the July policy statement that would signal an imminent rate cut.

But another concern is that inflation is "stuck" around the target of 2.6% or 2.7%, said Michael Strang, director of economic policy studies at the American Enterprise Institute, who is not advocating for the central bank to act in September.

Jan Hatzius, chief economist at Goldman Sachs, believes that waiting until September to cut interest rates will increase the risks the Fed is trying to avoid. He said: "If you wait, the risk on the economic side is that the labor market will deteriorate further. Given how much things have changed - how much inflation has fallen, how much the labor market has rebalanced - why not do what you might do in advance?"

Source: China Securities

Statement: All information content of Databao does not constitute investment advice. The stock market is risky and investment should be cautious.

Editor: Lin Lifeng

Proofreading: Yang Lilin

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