All eyes on the market! Will the Federal Reserve raise interest rates for the last time this round tonight?

Will July be the end of the Fed's current rate hike cycle? Markets are waiting with bated breath for any policy signals from the Fed. At 14:00 p.m. Eastern time on Wednesday, July 26 (02:00 a.m. Beijing time on Thursday, July 27), the Federal Reserve will announce its interest rate decision, followed by a monetary policy press conference by Federal Reserve Chairman Powell. The Fed will raise interest rates by 25 basis points at the FOMC meeting in July, and the market has been fully priced. At that time, the benchmark interest rate will rise to 5.25-5.5 per cent, the highest level in 22 years. At the same time, inflation in the United States has slowed more than expected, while economic and employment data remain strong, and the possibility of a recession in the United States in the next 12 months has dropped significantly. So the market for the FOMC meeting focus is: after the interest rate hike, the Fed's follow-up rate hike path how to interpret, has been up to 16 months of interest rate hike road will come to an end in July? is regarded as "the Fed's mouthpiece", "the New Fed News Agency" said the Wall Street Journal reporter Nick Timiraos "pre-meeting" said the Fed is expected to raise interest rates by 25 basis points in July. The real heart of the debate at the July meeting is: under what circumstances the Fed needs to raise interest rates again in 9 or in the fall * *. The slowing inflation data further strengthened the possibility of the Fed's last interest rate hike in July. At present, major Wall Street banks have no differences on the Fed's 25 basis point rate hike in July, but regarding the path of interest rate hike thereafter, * * only Barclays and Santander believe that there will be another interest rate hike before the end of this year * *, while * * Nomura, Goldman Sachs, Morgan Stanley and other institutions expect July to be the Fed's last interest rate hike this year * *, * Morgan Stanley, Nomura and Deutsche Bank believe that the Fed will begin to cut interest rates in the first quarter of next year * *, **Goldman Sachs, on the other hand, believes the rate cut will begin in the second quarter * *.! Because this FOMC meeting will not update the latest quarter's Economic Forecast Summary Report (SEP) and interest rate dot plot, attention will focus on whether Powell's announcement indicates that the Fed is about to turn, and his views on the current US inflation data. In this meeting, Powell's evaluation of the June dot plot was also crucial. Morgan Stanley noted in its report that they expect **Powell to be able to describe more clearly in this press conference what indicators the Fed will focus on in order to be assured of the direction of inflation. ## A 25 basis point rate hike in July is a foregone conclusion Institutions and investors have now fully priced the Fed's 25 basis point rate hike at this week's meeting. Current CME rate expectations imply a probability of a July rate hike of close to 100 per cent, corresponding to the US bond rate of 3.8 per cent, and the market is largely undivided. The "FedWatch Tool", the Fed's observation tool, shows that the probability of raising interest rates by 25 basis points in July has reached 98.9 percent.! Nomura Securities pointed out in its analysis that the Federal Reserve will raise interest rates by 25 basis points as expected by the market in July, and Powell will reiterate his view that he will raise interest rates once again after July. Nomura said in the report that Powell will also emphasize that " the rate hike is not over **", which he has been used to for 16 months, and July will be the last rate hike by the Fed as inflation continues to slow in the second half of 2023. Jan Hatzius, chief economist at Goldman Sachs, also believes that there is no doubt that the Fed will raise interest rates by 25 basis points in July, and this action is likely to be the last in the current interest rate hike cycle. Morgan Stanley analyst Michael Feroli believes that the Federal Reserve will not make any changes to the forward-looking guidance of "further interest rate hikes are reasonable". Feroli will look for a statement at the press conference that "Powell said that the dot plot in June is still of reference value, but the Federal Reserve has not yet made any decision on the future, and the policy depends on the data. Feroli stressed that Powell's comments on the dot plot are crucial, the dot plot shows two more rate hikes this year (including July), but Powell is likely to reiterate that any future decisions will depend on the data and is unlikely to make a strong commitment to future interest rate decisions. It is worth noting that in the Reuters survey, **only 19/106 economists believe that the U.S. terminal interest rate will reach the dot plot level. * *! ## Where should the Fed go after July? The path of raising interest rates after 7 months may become the focus of debate at this FOMC meeting, as well as the focus of market attention. **The rapid fall in inflation has led economists to bet that the Fed will not restart interest rate hikes after September. U.S. June CPI and PPI data both show inflation cooling significantly:> U.S. June CPI rose 3 percent year-on-year, the lowest since March 2021, and core CPI rose 4.8 percent year-on-year, the lowest since October 2021.>> The U.S. PPI also cooled more than expected in June to 0.1 percent, the lowest since August 2020, while the core PPI rose 2.4 percent year-on-year, below expectations and the lowest since February 2021. Nomura pointed out in the report that more and more evidence shows that inflation is slowing down beyond expectations, and the continuous improvement of inflation trend indicators (such as the median consumer price index or the average value of the reduction) indicates that inflationary pressures have eased. Non-consumer price index inflation data, such as the producer price index and business surveys, suggest that inflation will continue to slow. Former Federal Reserve Chairman Ben Bernanke believes that inflation could fall to 3-3.5 per cent more sustainably over the next six months as rental inflation fades and car prices fall. By early next year, U.S. inflation is expected to fall to a level of 3% or slightly more than 3%. After that, he expects the Fed to take its time and **try to get inflation down to its 2 percent target. * * Barclays stressed in the report that the unexpected decline in inflation data in June has reduced the need for the Federal Reserve to restart raising interest rates after September. However, with the recovery of economic activities and the continued hot labor market, the Federal Reserve's inflation target still needs time to verify:> We expect the FOMC to still doubt whether inflation will continue to decline and whether the Federal Reserve can achieve the 2% target without raising interest rates again. For the view that the Fed will stop raising interest rates after July, Barclays believes that this is not the case. Barclays expects the FOMC to raise interest rates by another 25 basis points in September or November in order to meet its inflation target * *. Compared with September, * * November is more likely to raise interest rates * *, and the inflation data in June gives FOMC more time to evaluate the effect of its past interest rate hikes:> although inflation has continued to slow down recently, this may lead FOMC to lower its forecast of future CPI, but unstable factors exaggerate the slowdown of core CPI:> > CPI decline is mainly affected by the base factor of crude oil price, price increases in other categories continue, and may even allow CP1 to rebound after the crude oil base factor disappears.>> The slowdown in core CPI is also affected by unstable factors such as medical expenses, accommodation expenses and air tickets, and the slowdown in core inflation has been exaggerated.>> We expect inflation to pick up in July from June, with core CPI growing at 0.23 per cent month-on-month (up 4.7 per cent year-on-year).>> ! Barclays stressed that the Fed's interest rate meeting will not have its favorite data-the core PCE price index in June. PCE inflation is expected to slow down in June, but to a lesser extent. * * While economic activity is more flexible and the labor market is tightening, it is difficult for PCE growth to slow down in the future * *:> we expect overall PCE to grow 0.16 percent month-on-month (3.0 percent year-on-year) and core PCE to rise 0.16 percent month-on-month (4.1 percent year-on-year) in June.>> Based on the latest CPI and PPI expectations, we believe that the month-on-month growth rate of U.S. workers' disposable income has accelerated from the previous month. This salary growth rate is very important for judging the future PCE growth rate: salary growth rate is the potential driving force for PCE growth rate. If the salary growth rate is high, it will be difficult for PCE growth rate to come down in the future.>> If you look at the month-on-month PCE growth rate, both PCE and core PCE could not keep up with the growth rate of disposable income in May.>> ! Fed Governor Waller (Christopher Waller), who permanently owns the voting rights of the Fed's monetary policy meeting FOMC during his term of office, said that he supports raising interest rates twice this year so that inflation can return to the target level, but Waller also admitted that if the CPI report for the next two months shows that the Fed's tightening has made progress, it "indicates that interest rate hikes may stop". Goldman's view on the Fed's post-July rate hike path is almost completely opposite to Barclays', with the sharp slowdown in core CPI in June becoming a turning point in the Fed's inflation story. Goldman Sachs stressed that high core inflation has become a key reason why most markets expect the FOMC to raise interest rates at least twice. But by the time the Fed meets in November, Goldman Sachs expects core inflation to continue its downward trend, which will gradually convince the FOMC that a second rate hike is no longer necessary.>! Goldman Sachs also gave a timetable for rate cuts, **the first rate cut is expected to be in the second quarter of 2024, with a quarterly rate cut of 25 basis points * *:

We have long argued that the Fed's rate cut threshold is quite high and that the FOMC will have to wait until some risk to economic growth or a sustained decline in inflation leads them to believe in this trend. According to our forecast, the FOMC will cut interest rates for the first time when the year-on-year decline in nuclear PCE is less than 3% and the month-on-month decline is less than 2.5. And even then, the FOMC may not cut interest rates.>> If economic growth is higher than the potential growth rate, the unemployment rate reaches a half-century low, and financial conditions are further relaxed, then the risk of loosening monetary policy may not be too high. Ultimately, the Fed's policy rate will remain at 3-3.25 percent, above the FOMC's long-term target of 2.5 percent.>> ! But until July 25, the market generally believed that the probability of raising interest rates twice this year was very low. * ! * ## The possibility of a" soft landing "is unprecedented?** Before declaring victory against inflation, the Fed wants to see a better balance between supply and demand in the labor market. **Bernanke pointed out that the current labor market is still hot. Although the number of JOLTS vacancies has declined, there are still about 1.6 vacancies for each unemployed person. Wall Street Seen Previous Article Mentioned, the ratio of job vacancies to unemployed people hit a record level of over 2 in March last year, which was 1.2 before the New Crown epidemic and is still significantly above this long-term trend level.! Bernanke predicted that the US economy may experience a slowdown, which is the price of fighting inflation. However, he stressed that even if there is any recession, it is likely to be mild, that is, a very moderate rise in unemployment and a slowdown in the economy. He would be very surprised if the U.S. economy experienced a severe recession next year. There are also analysts who argue that the Fed's aggressive rate hikes look and make employment significantly less, **but the" cost "is generally time-lagged * *. So far, the U.S. labor market has rebalanced by reducing vacancies rather than jobs: hiring remains strong and layoffs are rare. Wage growth has declined due to a decrease in job vacancies. However, no one knows how long the job market will remain in this ideal state: there is evidence that companies have been accumulating workers in the country that they do not actually need because of fresh memories of labor shortages; once companies think it is too expensive to retain workers that may or may not be needed in the future, * then the number of layoffs may increase in the short term. This is one of the specific manifestations of the lag in policy effects that Powell is concerned about * *. ## How are the subsequent asset movements? Barclays pointed out in its analysis that, in addition to the path of interest rate hikes, the impact of the continued advancement of the Fed's tapering program (QT) on the overall liquidity of the financial system is equally noteworthy and may have an impact on asset movements. Financial liquidity indicators (Federal Reserve Balance Sheet-TGA Account-Reverse Repo ONRRP Scale) have been affecting the trend of U.S. stocks and U.S. dollars since last year:> One of the reasons for the strong performance of the market in the second quarter is that after the banking crisis, the Federal Reserve has partially converted a large amount of liquidity into bank reserves in the form of short-term loans, while inflation is still falling.>> In the third quarter, the gradual maturity of Fed borrowing, continued tapering, and new Treasury issuance are expected to make financial liquidity shrink again, so the liquidity support faced by U.S. stocks in the third quarter will be weaker than in the second quarter, and the contraction in liquidity will also have some support for the U.S. dollar. U.S. debt: the short-term pivot remains near 3.8 percent, with room for faster downside in the fourth quarter. * * Analysts pointed out that the reasonable level of 10-year U.S. debt interest rate corresponding to another interest rate hike in July is around 3.8 percent, and the probability of another interest rate hike will limit the upward space of interest rates (if the rise will provide better opportunities for intervention), but at the time of the Fed's scale reduction, the U.S. government's deficit soared, further increasing the supply pressure on the bond market. That would keep the 10-year U.S. bond yield above 3.5 percent for the long term. As "old debt king Bill Gross (Bill Gross) said, while U.S. bond yields may have peaked this year, a bond bull market is unlikely to come * *. **U.S. stocks: The third quarter is between the" strong "in the second quarter and last year's" weak ", the fourth quarter may have stage pressure, loose expectations to cash in and then rebound. **The reduction in financial liquidity support will make the performance of U.S. stocks weaker than in the second quarter, but the amount of decline depends on whether the market will find an excuse (e. g., earnings, etc.) and pull back, generally showing a volatile pattern, if a sharp correction will provide opportunities for re-intervention. Warming growth pressures in the fourth quarter and a small warping of inflation may bring some adjustment pressure until it is forced into easing expectations to push U.S. bond rates down to hedge against tighter financial liquidity. **Gold: More gains or in the fourth quarter, the magnitude has been overdrawn. **Some institutional analysis pointed out that, according to the real interest rate of about 1% and the dollar 100~105 range, the central price of gold may be around $1900/ounce, the next wave of gains mainly waiting for recession and interest rate cut expectations to catalyze, this point may be in the fourth quarter. In addition, in terms of magnitude, the gap between gold and real interest rates has widened further since the beginning of the year, and may have overdrawn some of the expectations of a future fall.