Possibility of Fed rate cut amid inflation resilience

On March 22, the Federal Reserve announced that it would raise the target range of the federal funds rate by 25 basis points to 4.75% and 5%, maintaining the slowest rate hikes since March 2022, basically in line with market expectations.

Generally speaking, the goals of monetary policy include multiple aspects: economic growth, full employment, price stability, the balance of international payments, financial stability, and so on. The relationship between these goals is relatively complicated. For example, economic growth and full employment are consistent to a certain extent, while price stability, economic development, and balance of payments may conflict in some specific scenarios. Therefore, in any country, often, All of the above objectives cannot be met at the same time.

The two long-term monetary policy goals of the Federal Reserve are price stability and full employment, and the focus of goals may vary in different periods. However, regardless of whether it focuses on price stability or achieving full employment, there is a consensus that the prerequisite for the effective implementation of monetary policy is to avoid systemic risks.

After the Silicon Valley Bank incident, the risks facing the U.S. financial system surged. On March 10 local time, financial regulators shut Silicon Valley Bank (Silicon Valley Bank) down due to insolvency. And they appointed the Federal Deposit Insurance Corporation of the United States to manage the liquidation of Silicon Valley Bank. On March 12, local time, U.S. financial regulators took action to ensure the safety of depositors' funds and set up a new lending program funded by the Treasury Department. In addition to Silicon Valley Bank, New York State financial regulators closed SignatureBank, which focuses on cryptocurrency businesses, on March 12 local time. Although U.S. regulators fully protect depositors' deposits, the risks posed by the Silicon Valley Bank incident have not entirely subsided, and concerns about financial risks still hang over the market.

As early as the late 1960s and early 1970s, inflation in the United States had already shown signs of rising. To curb inflation, the New Economic Policy promulgated by Nixon in 1971 froze wages and prices, and inflation-external forces suppressed inflation years—more moderate growth. In 1973, due to the shortage of food supply, the cost of food soared, and before the outbreak of the oil crisis, the CPI had climbed to a high of 7.4%. Facing the rapid and sharp rebound of inflation, the primary goal of the Federal Reserve's monetary policy in 1973 was to stabilize prices. On January 15, 1973, the Federal Reserve began to raise interest rates, and the discount rate was increased from 4.5% to 5.0%. With seven interest rate hikes, the cumulative pace of interest rate hikes reached 300 bp. After the outbreak of the oil crisis, inflation rose further. Unlike before, the rapid rise in oil prices directly led to a significant decline in U.S. auto sales and consumer spending and a sharp slowdown in production and investment activities in the private sector. Slide. By 1974, the Federal Reserve's monetary policy faced dual pressures from economic recession and high inflation. When the two conflicted, the focus of monetary policy goals shifted from anti-inflation to reducing the uncertainty brought about by the oil crisis and stabilizing economic growth. On April 25, 1974, the Federal Reserve implemented the last interest rate hike in this round of the interest rate hike cycle, and the discount rate rose to 8.0%; in September 1974, the year-on-year growth rate of the U.S. industrial production index turned negative for the first time; on December 9, 1974, the Federal Reserve lowered the discount rate by 25 basis points to enter the interest rate cut cycle, while the inflation level in the United States was still high at this time. It was not until December 1974 that the CPI reached the staged high point of this round of inflation.

The Federal Reserve's March interest rate meeting did show some signs that the rate hike cycle is coming to an end. First, in the previous February Fed resolution statement, the Committee stated that to ensure that the monetary policy is sufficiently strict to allow inflation to return to the level of 2%, "it is expected that it is appropriate to continue to raise interest rates"; and in the latest resolution statement, "continued Interest rate hikes" were deleted and the related expression changed to "It is expected that some additional policy tightening may be appropriate." Second, judging from the latest interest rate dot plot released by the Federal Reserve, most Fed officials expect that by the end of 2023, the target range for the federal funds rate will be 5%-5.25%, which means that the Fed is likely to raise interest rates only once during the year. Space is 25 basis points.

The direct cause of the significant inflation in the 1970s was not the oil crisis. As mentioned above, before the outbreak of the first oil crisis, the US CPI had reached its highest level after the Korean War year-on-year. It can't be attributed to fiscal and monetary stimulus. After the 1980s, indicators such as the year-on-year growth rate of money and the fiscal deficit as a percentage of GDP exceeded those of the 1970s, and we have yet to see a resurgence of similar inflation. The real force that can lead to a continuous increase in demand mainly comes from changes in the stage of economic development itself. The constant and substantial increase in the proportion of young people in the United States in the 1970s was the core reason for the continuous and significant expansion of total demand.

The current inflation cycle started with a demand recovery after a solid monetary and fiscal stimulus round. It intensified with the help of supply-side factors such as the conflict between Russia and Ukraine. However, changes on the supply side will not lead to a continuous rise in prices, and the demand recovery brought about by policy stimulus will gradually fall back as the effect of policy stimulus disappears. The latest inflation data released by the United States shows that the CPI in the United States rose by 0.4% month-on-month in February, a new low since December 2022. The previous value was 0.5%. A new low since September, the last value was 6.4%; the core CPI without seasonal adjustment in February increased by 5.5% year-on-year, falling for the sixth consecutive month, a new low since December 2021, the previous value was 5.60%.

The second is the subsequent evolution of the Silicon Valley Bank incident. The possibility of a financial crisis is not high. Compared with the collapse of Lehman Brothers in 2008, the size of Silicon Valley Bank is much smaller, and the risk spillover effect is much lower than that of the collapse of Lehman Brothers. More importantly, after experiencing the financial crisis in 2008, the current Federal Reserve has richer experience in dealing with concerns and more complete monetary policy tools. Compared with Lehman Brothers, the rapid response of the U.S. regulators in the Silicon Valley Bank incident has primarily prevented the spread of the risk of a run on U.S. banks.

1) Inflation is declining, and there may be some resilience in the future, but there will be no high inflation in the 1970s;

2) The risks brought by the Silicon Valley Bank incident have not entirely subsided, but it is unlikely to evolve into a financial crisis;

3) There is a high probability that the subsequent economy will weaken. The Federal Reserve also lowered its economic growth forecast for this year and next in its latest economic forecast report. The current round of the Fed's interest rate hike cycle has ended, and the end of the U.S. rate hike is a relatively clear positive signal for global equity assets.

Risk warning: The macro economy is not as good as expected, the overseas market fluctuates wildly, historical experience does not represent the future, etc.