Tao Dong is a director of the China Chief Economist Forum
Sorrow and joy. While the market was basking in the frustration of the US economy overheating and the prospect of a rate cut, two surprises broke last week. The first is that the Fed really intends to reset the path of rate cuts, but Powell's tone is surprisingly mild and reduces the size of the liquidity extraction. The second is that the US non-farm payrolls growth has slowed sharply, giving the market a shot in the arm. After the release of the employment data, the swap market rekindled hopes of two rate cuts this year, with the first rate cut occurring in September at 50:50 and November at nearly 100%. In response to these two surprises, the bond market rose sharply twice, with the two-year Treasury yield falling nearly 20 points in a week. U.S. stocks led the global stock market rally, with Hong Kong's Hang Seng Index rallying particularly fiercely.
Funds became more positive about interest rates, and the dollar retreated. The U.S. dollar briefly approached the 160 mark against the yen, but was quickly crushed by suspected government intervention and closed at 153. There are signs of easing in the Middle East, with Brent crude oil futures falling sharply and precious metals prices also retreating.
The Federal Reserve Open Market Committee (FOMC) decided to postpone the start of the interest rate cut process. This is not to postpone the timing of interest rate cuts, but to readjust the view on the economy and inflation. In the words of Chair Powell, "it may take longer to be confident enough that inflation is sustainably moving towards the 2% policy target". As for when interest rates can be cut, Powell said he doesn't know.
Since the beginning of this year, inflation in the United States has been higher than expected, and price control has begun to stagnate. The job market remains buoyant and is transmitted to service prices through wage increases, creating a wage-price-inflation spiral. Whether it's inflation or consumption, employment or growth, economic data continues to deviate from the Fed's (and the market's) expectations, forcing monetary policymakers to reassess the economic situation, and the policy operation mode has been retraced from "preparing to cut interest rates" to "watching the state".
I suspect that it will be very difficult for the US to achieve the 2% inflation policy target, and it may not even be achieved until the economy is brought down. The rapid decline in inflation last year was largely due to supply chain shocks and energy price shocks, not the Fed's contractionary policies. The Fed's policy has only had a dampening effect on domestic demand, but it seems that employment and consumption are still strong, and the policy is not enough to cool domestic final demand.
Judging from the economic data, it is true that the Fed has no reason to cut interest rates, and Americans' dissatisfaction with the rising cost of living is high, so it is appropriate for the Fed to hold on to it, and it is appropriate for the official position not to give a clearer hint about the timing of the rate cut. These were made clear in the FOMC's post-meeting statement and Powell's press conference. Next, Powell changed his tune and suggested that the next interest rate action to cut interest rates is more likely than to raise interest rates, and at the same time, the FOMC decided to scale back bond purchases from June to leave more liquidity in the system, and tapering to reduce the size.
Powell did what had to be done by gently signaling a delay in cutting interest rates, but at the same time calmed the market's anxiety. Capital markets were relieved to avoid a major upheaval in asset prices. But the Fed did revise its plan for rate cuts this year, returning to the wait-and-see attitude it had for most of last year.
The author believes that the United States will still cut interest rates this year, but the trigger point may not be economic data, but financial stability considerations. High interest rates and troubled commercial properties (offices and shopping malls) have left small and medium-sized banks under pressure from liquidity and bad debts. The Fed is concerned about financial risks, but it can't be articulated publicly, just like a fire truck can't hit the streets until it's fire. At the same time, the U.S. fiscal deficit is accumulating at a frantic rate, and reducing the government's interest expenses by cutting interest rates is also an unspeakable factor for the Fed to consider.
The FOMC has just decided to postpone the start of the interest rate cut cycle, and the job market there has sent out the first weak data point of the year. Non-farm payrolls added 175K in April, significantly lower than market expectations of 250K. February and March data also revised below 22K, with leisure, hospitality, and construction employment slowing and health and retail remaining strong. Hourly earnings rose 0.2% month-on-month and 3.9% year-on-year, the slowest wage increase since mid-2021.
Employment data has always been very volatile, and post-mortem corrections are common, so a month's worth can be used as a reference, but you have to look at the next two data points. The Fed has just reset its interest rate policy direction and will not change its stance because of this data. In the author's opinion, the 175K job creation is still strong at the end of the cycle, which is a return to normal level and is not enough to change the decision-making thinking of policymakers. The new job creation data continues to fall below 100K before it affects the interest rate policy.
Overall, business activity in the United States is slowing, ISM data has slowed, consumer confidence is starting to weaken less than expected, rising prices are starting to eat into real purchasing power, household savings are falling, and debt is rising. The author firmly believes that the Fed's next policy move is to cut interest rates, but since the Fed has already made the decision to reset the course, I am afraid it will have to wait at least six months. In the short term, it is possible that events will lead interest rate cuts, and there will be no data-led rate cuts.
The yen played a Rashomon last week, falling as close as 160 against the dollar before rebounding to 153 after two suspected government interventions. More interestingly, the Japanese government openly asked the US government not to suppress the yen exchange rate, while the US Treasury Secretary called on Japan not to intervene in the exchange rate.
First of all, the author believes that the main reason for this round of yen depreciation comes from the United States, which is the reflection of US inflation data and interest rate policy. Second, the yen carry trade is revived, and the market believes that although Japan has come out of the era of negative interest rates, the chance of a large interest rate hike is low, and the interest rate differential between the United States and Japan is huge, and the cost of borrowing yen is still very cheap. Third, despite repeated statements from the Japanese government and central bank, the market believes that Japan is opposed to the speed of the yen's depreciation, not the direction of the depreciation.
In fact, the "cheap yen" has been the consistent position of the Japanese authorities over the past decade or so, and it is also the pillar policy of Japan to get out of the deflationary predicament. At this point, Japan can be said to be a larrow eater, and it is not willing to give up easily. The weak yen has brought about an unprecedented boom in tourism, and it has also whitewashed the earnings of many listed companies to help the stock market.
However, the sharp yen has also had side effects. Japan is an importer of energy, raw materials and food, and a low exchange rate means that the cost of imports has risen, which has increased the upward pressure on prices, eroded the purchasing power of consumers, and also dragged down the trade balance. For enterprises facing domestic demand, on the one hand, costs have risen sharply, but on the other hand, there is not much room for price increases, which compresses profits. The cheap yen is a boon for overseas tourists, but it is a burden for most domestic consumers, threatening the budding recovery of consumption.
The U.S. needs a strong dollar to support overseas money to buy dollar assets, and Japan needs a weak yen to get out of the deflationary mentality, so the two countries have been at peace for the past few years. But when the yen exchange rate suddenly plummeted, the Japanese authorities could not sit still. Japan's unilateral exchange rate intervention has rarely been a lasting success. In order to completely stabilize the exchange rate, Japan's economic fundamentals need to be structurally improved, and the huge amount of Japanese money stranded overseas needs to be returned to China. These two points are not visible for the time being.
There are three key points to focus on this week: 1) The Bank of England meeting is expected to keep interest rates unchanged, but hints that interest rate cuts are in sight. 2) The University of Michigan Consumer Sentiment Index is expected to weaken further. 3) The scale of social financing in China may decline seasonally.
