Cheng Shi is the Chief Economist of ICBC International and a member of the Board of Directors of the China Chief Economist Forum
On January 25, Eastern time, data released by the U.S. Bureau of Economic Analysis showed that the U.S. real gross domestic product (GDP) in the fourth quarter of 2023 grew at an annualized rate of 3.3% quarter-on-quarter, much higher than the expected value of 2.0%, lower than the growth rate of 4.9% in the third quarter, and higher than the growth rate of 2.1% in the second quarter and 2.2% in the first quarter. The market reacted mutedly and increased bets on the Fed to cut interest rates starting in March. As the Fed's rate hike cycle comes to an end, the debate about whether the expected inflection point for growth will be a soft landing or a recession in 2024 continues, and this could be a key factor ultimately shaping the path of interest rates.
What is the expected state of the U.S. economy in 2024? The pace and intensity of interest rate cuts will exceed expectations? The market expects interest rate cuts to exceed the Fed's current dot plot, will too large a gap in expectations cause risks? What is the spillover effect on emerging market countries? What impact will it have on China's monetary policy? What will be the next step for U.S. stocks? Will U.S. core inflation eventually be higher than the expected target? CBN's "Chief Countermeasures" interviewed Cheng Shi, chief economist of ICBC International.
Cheng Shi's main points:
Under the three scenarios for the U.S. economy, a minimum rate cut of 175 basis points is expected
Three factors determine the effectiveness of monetary policy
Larger-than-expected monetary policy choices are more effective for the United States
The Fed's relatively conservative dot plot projections have three considerations
In order to achieve the established effect, monetary policy may be at a certain distance from market expectations
If the Fed pivots to cutting interest rates, there will be more room for domestic monetary policy
The start of the interest rate cut cycle is a good boost to risk appetite
In the face of future market fluctuations, we should actively defend ourselves and follow the trend
There is still the last mile to the core inflation target
Under the three scenarios for the U.S. economy, a minimum rate cut of 175 basis points is expected
CBN: Mr. Cheng, thank you for accepting our interview to talk about the Fed's policy, and recently we have seen that the chief economist's views are also very different. First of all, you think that the Fed's interest rate cut will definitely exceed expectations in the future, so how do you judge when many people think that the minutes of the December interest rate meeting may not be so hawkish?
Cheng Shi: Because the minutes of the Fed's monetary policy meeting in December, its dot plot forecast is that the Fed gives a 75 basis point rate cut, then we think that the 75 basis point range may be small, then it may correspond to a relatively good state of the US economy.
There are three possible states for the U.S. economy in 2024. The first state is a soft landing, which means that the growth rate of the U.S. economy will fall slightly from about 2% in 2023 to about 1.5%, then it is indeed landing, but relatively speaking, the magnitude is relatively small. In this state, our judgment is to cut interest rates by 175 basis points, then this is the first scenario, and the second scenario is a hard landing of the US economy, which means that the US economy will have a technical recession, and the economy will have negative economic growth for two consecutive quarters, then the market's judgment is about 250 basis points to 300 basis points.
The third scenario is non-landing. The U.S. economy will probably maintain the same growth momentum in 2024 as in 2023, so if there is a slight decline in the economic growth rate, the decline will be very small. In this case, then the Fed will cut interest rates by about 75-100 basis points. So it is obvious that such a forward guidance given by the Fed itself corresponds to a relatively strong state of the US economy, and I personally think that the probability of this state is about 30%, and the first two are probably more than 65%.
Therefore, my judgment is that there will be a high probability of exceeding expectations, exceeding expectations means that there is a greater probability of the first two situations, it will be more dramatic on the path, and when the interest rate really starts to be cut, it will be in March at the earliest, then there is a high probability of May, June or July. So if you actually start cutting rates, it's actually going to be much faster than we're seeing now.
Three factors determine the effectiveness of monetary policy
Larger-than-expected monetary policy choices are more effective for the United States
CBN: At the same time, you think that the fiscal policy and monetary policy of the United States may be inconsistent in 2024, and if you think that the fiscal policy may contract, the conductivity of monetary policy will become worse, so its pace and strength will exceed expectations. Can the final or extreme state describe what the situation is?
Cheng Shi: Under the conditions of a modern market economy, the effectiveness of monetary policy depends on three factors: the first factor is that when you are at the starting point, if you are going to start cutting interest rates, that is, whether the monetary tightening situation at your starting point is tight enough, if you start to fall from a very difficult point and start to fall at a very high point, the effect will be better; then the second factor that determines the effectiveness is the mutual coordination of the entire monetary policy and fiscal policy, and if there is a conflict between the policy, the effect will actually be discounted to a certain extent; then the third very important factor is the stability of the entire geopolitics, that is, the uncertainty of the market. So if the geopolitical situation is unstable, then in fact, the negative effect on monetary policy will be relatively large, that is, even if you do a lot of monetary policy, it may not have an effect.
So from the perspective of effectiveness, I think this is why we judge why the Fed needs to be stronger, because 2024 is a geopolitical year, and at the same time, 2024 will inevitably see a certain conflict between U.S. fiscal policy and monetary policy, so in this state, it can only make strong policy more effective through choices that exceed expectations.
The Fed's relatively conservative dot plot projections have three considerations
CBN: So I see that the dot plot given by the Fed is 75 (basis points), your forecast is 175, and the more aggressive foreign institutions are 275, and we assume that the Fed is now 75 in the end, if there is too much difference from market expectations, do you think there is any risk?
Cheng Shi: I think there are several reasons why the Fed gives a relatively conservative monetary policy dot plot forecast. The first reason is that he wants to be more stable in his transformation, that is, the expectations given at the beginning are not too full, which is understandable. So I think the other point is that as I mentioned earlier, it is relatively confident in the U.S. economy, and I think there is still some truth in this self-confidence, and from the current micro data, the U.S. economy is still okay. The third and most important reason is that any monetary policymaker has an instinct to be inconsistent with his words when he makes a big policy shift.
In order to achieve the established effect, monetary policy may be at a certain distance from market expectations
Yicai: Yes, this Powell is particularly obvious, last year, every interest rate meeting seemed to be swaying from side to side.
Cheng Shi: You see the same when the interest rate hike was raised, he first said that our inflation is actually not long-lasting, so inflation does not have a long-term sustainability, but then it really increased sharply. So this dynamic, this inconsistency between words and deeds, actually has a special model in the theory of our economics. So what are we talking about? That is, monetary policy, if it wants to achieve its intended effect, it must do one thing, especially in an efficient market, the market reacts relatively quickly, and it must achieve dynamic inconsistency. It is the final choice of your monetary policy, which must be at a certain distance from market expectations, so that the effect can be achieved.
Because in an efficient market, all of your expected policy actions are price in. So what are the risks of this kind of exceeding expectations that you mentioned? So I think first of all, it has returns, and the risks must correspond to the returns, and the benefits may allow the Fed to better achieve its stated policy effects, so what are the risks? The risks will naturally bring greater impact on the market. So for the U.S. market and the global market as a whole, then this unexpected policy choice will bring about a greater volatility in the whole market, and I think this is an undoubted risk.
The spillover effect of the Fed's interest rate hikes is more reflected in the economy
Interest rate cuts could still have a negative impact on vulnerable economies
Yicai: In fact, when we see this round of Fed interest rate hikes, it will not have as much impact on emerging market countries as before. So if it reverses, what do you call this spillover effect on emerging market countries? Is it good or bad? Or is it all of this that didn't have an impact before, and when monetary policy pivots, it starts to affect at the point where it cuts interest rates?
Cheng Shi: Actually, you have raised this topic very well, and in fact, some people are discussing why there is no such thing as the Asian financial crisis in this round of interest rate hike cycle. Actually, I don't think this is to say that the spillover effect of the Fed's interest rate hike is small or anything, I think on the one hand, it is more reflected in the economic level than the financial level.
Because the financial level in the last two years has actually been a situation of tightening global liquidity, then in this situation, it is actually a general survey of risk appetite, not aimed at anyone, everyone is the same. So in this case, emerging markets do not show an additional crisis. On the other hand, from an economic point of view, we can see that the entire world's major emerging market economies, including the Asia-Pacific region and Europe, will be greatly affected by the real economy and trade in this round of Fed interest rate hikes.
Therefore, when this round shifts from interest rate hikes to interest rate cuts, I think that from the perspective of monetary and financial conditions and economic conditions, this impact is relatively speaking, and in terms of its choice of interest rate cuts, it is a loosening impact on everyone. But on the other hand, if it has some unexpected disturbances, whether it can withstand them for the fragile emerging market economies is another story.
If the Fed pivots to cutting interest rates, there will be more room for domestic monetary policy
Yicai: Last year, many people thought that our interest rate cuts and RRR cuts were not enough, and the intensity was not enough, if you think that the Fed cut interest rates more than expected, do we have more space?
Cheng Shi: I think first of all, China's monetary policy must be based on prudence and self-centeredness, so it has not been affected much by the Fed in the past few years. On the other hand, there is still a certain misalignment between China's economic cycle and the U.S. economic cycle. So I think the relative impact on China will be slightly more indirect or smaller than that of other emerging markets. Because China is big enough, China's economy is large enough, and its ability to withstand shocks or impacts is relatively greater.
But one thing you have to admit is that if the Fed starts cutting interest rates, I think it's a good thing for China. As far as the choice of monetary policy is concerned, it is even more able to let go of me. Then because the pressure on the exchange rate will be much smaller, including in 2023, it will also experience some impacts on the flow of relatively large funds, so these effects will form some constraints on monetary policy. I believe there will be more positive changes to these effects this year.
The start of the interest rate cut cycle is a good boost to risk appetite
Yicai: One of the biggest opportunities is that after no longer tightening, U.S. stocks may continue to rise, do you think this possibility is very high? Because in fact, U.S. stocks have risen very outrageously in recent years.
Cheng Shi: With the start of the interest rate cut cycle, it is actually a very good boost for risk appetite. So actually, we looked at one of the performances of U.S. equities over the past few decades during the Fed's rate cuts. Then you will find that in the process of turning from hawk to dove, the performance of U.S. stocks in the capital market is generally positive. Therefore, we will feel that after a necessary adjustment in US stocks, and then with the liberalization of US monetary policy, there is still the possibility of further positive performance in the future.
In the face of future market fluctuations, we should actively defend ourselves and follow the trend
Yicai: In terms of risk, short-term volatility may affect investors' asset allocation, how do investors deal with this?
Cheng Shi: I think that because 2024 is a very important economic and financial inflection point, we are in a situation where not only monetary policy, but also many other important changes at the economic level.
In fact, from the second half of 2023, there has been a very special phenomenon. We know that equity indices across MSCI Worldwide are up 20% in 2023, and risk assets are doing well. But on the other hand, risk-free assets are also performing very well, we all know that yen assets are performing very strongly in 2023, so on the other hand, gold is also hitting new highs. So this is an environment where both risky and risk-free assets are rising, what does that mean?
That is to say, you must not only have enough awareness of risks and have some risk-averse behaviors, but on the other hand, you also need to make a layout in advance. So why are both risky and risk-free assets rising? While everyone is eager to try, there is still enough prudence on the other hand. Therefore, if our audience is more ordinary investors, I suggest that everyone should be more active and defensive, prudent judgment, and follow the trend.
There is still the last mile to the core inflation target
CBN: So this means that inflation in the United States will basically not return to the core inflation target that was predetermined before, right? Basically, the overall level of inflation will rise to about 3%?
Cheng Shi: At present, the year-on-year growth rate of CPI in the United States is a little more than 3.0%, and from 3% to 2% in the future, of course, 2% is core inflation, so I think there is still the last mile to go, and the last mile is actually very difficult to walk.
Because this round of inflation comes more from the impact of the supply side, then in fact, the last mile will actually make the Fed pay a bigger price, and the U.S. economy will pay a bigger price. That's why I think U.S. monetary policy will exceed expectations. Because in the future, if you want to achieve a more one percentage point decline in the CPI, then the corresponding economic sacrifice rate, which is what we see in the United States, is likely to rise even more.
Therefore, in this case, generally speaking, monetary policy should either not be relaxed, and the relaxation must be strong enough. Therefore, I think this is also an effect of the change in inflation in the United States on the overall monetary policy of the United States. vvv
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