As expected, the Fed announced another 75 basis point rate hike at the Fed's July FOMC meeting, which ended in the early morning of July 28, raising the federal funds rate to 2.25%-2.5%, levelling the highest level since the last round of rate hikes at the end of 2018. So far, the Fed has raised interest rates four times in a row during the year, and two consecutive 75 basis points, anti-inflation has become the primary goal of current monetary policy.
Meanwhile, balance sheet drawdowns are scheduled to accelerate in September, with monthly reductions in mortgage-backed securities (MBS) increasing to $35 billion and government debt at $60 billion.
The market reacted positively, with the U.S. stock market widening gains after the rate meeting, with the Nasdaq closing up 4 percent, the S&P 500 up 2.6 percent, and the dollar clearly weakening to 106. In contrast, the performance of US Treasuries is more "calm", and the 10-year US Treasury interest rate has remained around 2.8%.
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The 75bp hike is in line with market expectations
Industry analysts believe that the aggressive interest rate hike of the US and European central banks is generally in line with expectations.
Wen Bin, chief economist of Minsheng Bank, pointed out that although Powell said after the June interest rate meeting that the 75bp rate hike is not the norm, from the minutes of the meeting, the 75bp interest rate hike in July is indeed within the fed's consideration. With the US CPI data in June hitting a 40-year high of 9.1% while the unemployment rate remains low at 3.6%, the market has long expected a 75bp rate hike in July, and even thought it was more likely to add 100bp. On July 26, THE CME's interest rate watch tool FedWatch showed that the probability of a 75bp rate hike by the Fed was 72.7%, and the probability of a 100bp rate hike was 27.3%. From the perspective of the euro area, the CPI in July also continued to brush a record high of 8.6% year-on-year, while the unemployment rate has been at an all-time low until May, when it was 6.6% in May. The minutes of the ECB's June meeting also noted that action in increments of more than 25 basis points if necessary is not ruled out. Therefore, in the case that anti-inflation has become a common priority of the Federal Reserve and the European Central Bank, the aggressive interest rate hike of the US And ECB in July is generally in line with expectations.
The Office of the Investment Director (CIO) of UBS Wealth Management issued an institutional view that the Fed's interest rate hike last night was less important than convincing the market that inflation was under control. After the interest rate vote, U.S. 10-year breakeven inflation rose 8 basis points to 2.44 percent, but remained below 4, peaking at 3.1 percent. Markets expect policy rates to rise to around 3.25% by the end of the year, which means the Fed will tighten some 100 basis points further by December. The pace of rate hikes will still depend on the rate at which inflation eases, and given that recent growth data has been weakening, the market is convinced that policy is about to reach an inflection point. However, until the Fed gets evidence of cooling inflation, it believes that investor sentiment will not be able to improve sustainably. Growth stocks have recently pushed for a rally in equities as yields have retreated from their peaks, with the MSCI World Growth Index up 4.8 percent so far this month and only 1.6 percent during the value index period, but the trend is unlikely to continue. While inflation is likely to decline in the coming months, it is estimated to remain above the central bank's target. Since 1975, value stocks have tended to outperform when inflation is above 3 percent. In addition, the valuation of growth stocks is still relatively expensive, with the Russell 1000 Growth Index price-to-earnings ratio 70% higher than the Russell 1000 Value Index, which is twice the long-term average of 35%.
Zhou Maohua, a macro researcher in the financial market department of Everbright Bank, believes that the Fed's interest rate decision, the Fed admitted that the risk of recession has increased, and the pace of interest rate hikes at some point in the future will slow down. As for the reasons for the Fed's slowdown in the pace of interest rate hikes, Zhou Maohua said that considering that the Fed has gradually entered the middle and back stages of interest rate hikes, the interest rate environment has further tightened, and the Fed has caused a serious impact on the economic recovery by appropriately slowing down the pace of interest rate hikes and minimizing policy tightening. Recently released data show that US consumption and investment spending have slowed down, indicating that the economy is slowing down. He expects at least 100bp rate hikes in the 3 subsequent policy meetings during the year, and the Fed wants to curb high inflation as soon as possible, maintain its reputation, raise rates in front, and raise rates in September, November, and December: 50bp, 25bp and 25bp, but if inflation exceeds expectations again in August, it is not ruled out that the Fed will raise interest rates by 75bp or higher in September.
BoC Research also believes that the pace of interest rate hikes by the Fed in the future may slow down. In terms of interest rate decisions, the Fed reiterated that it was appropriate to keep rate hikes and was firmly committed to its goal of bringing inflation back to 2 percent. Inflation in the U.S. is currently high, with CPI up 9.1 percent year-on-year in June, a nearly 41-year high. This reflects the supply-demand imbalances associated with COVID-19, rising energy prices and broader price pressures, while the Russian-Ukrainian conflict and its related events put additional upward pressure on inflation. As a result, the Fed is "highly concerned about inflation risks" and will continue to significantly reduce the size of its balance sheet. In terms of the pace of rate hikes, it may be appropriate to slow down rate hikes at the right time as interest rates rise to highs. The Fed's future path to rate hikes depends on economic data and will not provide policy guidance for the September meeting. The Fed wants to raise interest rates to a moderately restrictive level of 3.0%-3.5% by the end of the year.
What is the impact on U.S. stocks and the U.S. dollar? How to affect the continent
U.S. stock market gains widened after the rate meeting, with nasdaq closing up 4 percent, the S&P 500 up 2.6 percent, and the dollar weakening markedly to 106.
Zhou Maohua, a macro researcher at the financial market department of Everbright Bank, is still cautious about the follow-up trend of US stocks, mainly because the Fed is in the middle and back end of the interest rate hike, and the balance sheet reduction has just started, at the same time, the US economy is slowing down, and the risk of recession next year is rising; From the corporate level, the demand outlook is slowing, the financial environment is tightening, the dollar is strong, etc., the US corporate earnings outlook is weakening, and the valuation of US stocks is high.
On the dollar side, it said that the dollar maintained a strong pattern. The Fed continues to collect water for the good dollar; From the trend point of view, Europe is facing a more complex political and economic situation, which means that there is a significant difference in economic fundamentals and policies between the United States and Europe.
How does the Fed's strong interest rate hike affect the trend of A-shares and the renminbi?
In this regard, Zhou Maohua first analyzed the policy level: domestic grain harvest year after year, production and life to accelerate the recovery policy, domestic supply and price stabilization measures have not decreased, pig production capacity has been restored to the perennial level, the supply of residents' daily necessities is sufficient, and the overall price trend is moderate and controllable; Coupled with the fact that the financial system remains stable, mainland policies remain independent.
Speaking of the stock market, he believes that the Fed's policy has limited domestic impact, mainly because China and the United States are in different economic and policy cycles, and a country's stock market will eventually return to its own economic fundamentals.
From the trend point of view, the domestic economic development prospects, the stock market trend is highly certain, the correlation between RMB assets and other markets is not high, the RMB exchange rate trend is stable, the pace of RMB internationalization is accelerating, etc. In the environment of complex global political and economic prospects and violent market fluctuations, RMB assets are expected to become a safe haven for global funds.
Sustained rate hikes are accumulating financial market risks
Cheng Shi, chief economist of ICBC International, believes that the continuous interest rate hike is accumulating financial market risks. Historically, continued sharp rate hikes have dampened highly sensitive interest rates (such as loan or mortgage rates) in the short term. However, if the policy interest rate continues to rise and the adjustment is too high, in the overall contraction of the financial market and the overall debt to GDP is high, the hidden danger of the increased debt burden will enhance the financial market's response to the continuous policy tightening, and when this continuous behavior accumulates to a certain moment, the financial market may have a "collective" panic, which will lead to a large-scale asset adjustment in some markets (such as the real estate market). The rapid rise in total U.S. debt levels in the wake of the pandemic has amplified the sensitivity of financial markets. Specifically, the Debt to GDP ratio of the United States has risen from 106% before the pandemic to 137%. In addition, the debt service ratio of U.S. households (reflecting the debt service ratio of U.S. household debt service as a percentage of disposable income) improved rapidly after the fourth quarter of 2021. If, heading into the second half of the year, the US interest rate hike in September or December remains at 75 basis points, then a further rise in the US household debt service ratio may exacerbate the rapid adjustment of the US household sector in financial assets, which will lead to further amplification of financial instability. What worries the market even more is that the Fed's monetary policy has put inflation control in the first place.
Thus, the burden of maintaining financial stability or assuming financial risks falls on other parts of the monetary policy framework. However, whether from the new Taylor rule, the forecast targeting system, or the Fed's four "compensatory" strategies (such as average inflation targeting, nominal GDP targeting, etc.), the Fed's monetary policy framework still lacks how to deal with the vulnerability risks accumulated in financial markets in the process of strong interest rate hikes to control inflation. This long-term accumulation of financial risks often leads to economic derailment and accelerates a hard landing. Until the Fed is unable to come up with a more proactive and effective financial stability policy, a phased slowdown in the pace of rate hikes may be a trade-off.
At the same time, the US economy has weakened domestic demand momentum, deteriorated growth prospects, and is also facing the risk of a "technical" recession.
BoC Research Analysis notes that the Fed acknowledges that spending and production indicators have weakened recently. According to the latest forecast of the Federal Reserve Bank of Atlanta, the real GDP of the United States in the second quarter of 2022 will shrink by 1.2% month-on-month at an annual rate, negative growth for two consecutive quarters, and fall into a "technical recession". First, there are signs of weakness in residents' consumption. According to the World Federation of Large Enterprises, the U.S. consumer confidence index fell to 95.7 in July, down 2.7 from June and the lowest since February 2021. Concerns about inflation, particularly rising gasoline and food prices, weighed on consumption. Consumer purchases of cars, homes and major appliances all fell further in July as the Fed raised interest rates to contain inflation. Second, the production and operation activities of enterprises have slowed down. High inflation dampened demand for service providers, causing factory orders and production to contract across the board. According to S&P Global data, the U.S. composite PMI for July was 47.5. Among them, the initial value of the service industry PMI is 47, the initial value of the manufacturing PMI is 52.3, and the preliminary value of the manufacturing output index falls below the 50 boom-bust line, hitting a new low in two years. Third, real estate sales have declined significantly. In the first half of 2022, U.S. home sales fell sharply, from a high of 6.49 million in January to 5.12 million in June, a 21% drop. Cancellations of home sales contracts jumped from a relatively normal 12.7 percent in May to 14.9 percent in June.
It is worth noting that the spillover effect of the Fed's continuous interest rate hikes is obvious, and the BANK OFC study reminds emerging markets to be vigilant of three major risks: First, tight monetary policy suppresses global demand, resulting in slower economic growth in emerging markets. In the context of the Fed's interest rate hike, global financial conditions have tightened and the financing environment has deteriorated. The cost of refinancing by SMEs and low-rated firms has increased, and the risk of credit default and bankruptcy has increased, which in turn has inhibited investment and economic growth. Second, the US dollar continues to strengthen, and the depreciation pressure of emerging market currencies has increased. Faced with the dual pressure of high inflation and a higher dollar index, some emerging markets have fallen into currency crises, or even financial crises. Since 2022, emerging market currencies such as Sri Lanka, Laos and Turkey have depreciated by 44.6%, 25.4% and 22.2% against the US dollar, respectively. Some financially vulnerable countries even face sovereign debt risks. Third, emerging markets have suffered capital outflows. Capital outflows from emerging markets have accelerated since March 2022. The Emerging Markets Portfolio continued to net outflow from March to June, with a cumulative outflow of US$42.7 billion. Among them, the net outflow of portfolio funds in June was $6.6 billion.
Has the Fed passed the fastest tightening phase?
Has the Fed passed the fastest tightening phase? In this regard, the team of CICC Liu Gang, Li Hemin and Li Yujie analyzed that "the fastest stage of Fed tightening may be close to the past." ”
"In the benchmark scenario, we tend to prefer that the fed's fastest phase of tightening is close to the past, mainly considering that tightening is close to completion, inflation may have a partial easing, and growth pressures are beginning to rise." However, there are still some variables ahead of the September FOMC meeting, so from a relatively more secure point of view, there may be more clues as to whether the tightening will be able to completely slow down and regress. ”
On the whole, the market's early game of expectations for future policy decline is not completely unreasonable, and the Fed policy may indeed be close to the fastest stage of tightening, but it is not difficult to see from the above analysis that there are still variables in the process, such as the inflation path for the next two months, the US second quarter GDP data to be released, and the us stock market second quarter results that are currently being disclosed. Therefore, during this period, it is not excluded that there will be repeated games of expectations, especially around key economic data, from a more stable and right-handicap perspective is to wait until the policy decline and inflation decline are more clear, and this point in time corresponds to after September from the current forecast of the team of CICC Liu Gang, Li Hemin and Li Yujie.
Li Chao, chief economist of Zheshang Securities, believes that the 75bp interest rate hike returns to the neutral interest rate, and Powell's policy stance is dovish and the annual tightening slope has overturned the steepest slope.
In terms of interest rate range, the Fed raised interest rates by 75bp to raise the benchmark interest rate range to 2.25%-2.50%, and the policy interest rate ceiling also officially touched the neutral interest rate; The reverse repo rate and the excess reserve rate (IOER) as an overall interest rate corridor were also raised by 75bp, in line with market expectations and slightly lower than we had previously expected. Before the meeting, the federal funds rate futures priced the probability of a rate hike of 75bp in July, a 50bp hike in September and November, and stopped raising rates in December. The corresponding policy rate at the end of the year is 3.25%-3.50%, exceeding the neutral interest rate by nearly 100bp.
In terms of balance sheet reduction, the Fed will continue to implement according to the original plan, with a speed of $47.5 billion / month this month (30 billion Treasury bonds + 17.5 billion MBS), and from September onwards, the speed will increase to 95 billion US dollars / month (corresponding to 60 billion Treasury bonds + 35 billion MBS). From the perspective of the end of the balance sheet reduction, the current neutral forecast of the Fed is: the balance sheet reduction will continue until mid-2025, with a total balance sheet size of $2.5 trillion; the balance sheet size corresponding to the end of the balance sheet reduction is about $5.9 trillion (estimated to account for 22% of GDP), and the corresponding reserve size accounts for 8% of GDP. It should be noted that this path is only a calculation given by the Fed based on the asset maturity structure, and the future policy path will still be decided according to fundamentals and liquidity conditions.
Looking ahead, Li Chao believes that this month's Fed interest rate hike of 75bp (taking into account the Fed statement and the policy stance of Powell's post-meeting reporter questions and answers) also basically confirms that the most hawkish time of the Fed in the whole year has passed, and the tightening slope of the whole year has turned over the steepest slope.
Edited by Chen Li Proofreader Wang Xin