【MACRO Alert】The Fed’s decision-making dilemma? The economic game behind the interest rate decision and CPI data!

The Fed's contradictory stance and market expectations

The June Federal Reserve interest rate meeting presented a contradictory stance. On one hand, May's inflation data showed a broad-based cooling, especially with core inflation turning negative month-over-month for the first time since September 2021, raising hopes for rate cuts. However, the Fed seemed unmoved by this “good news,” maintaining at least one rate cut in its dot plot, which contrasts with market expectations of two cuts.

This cautious rate-cutting strategy has not convinced the market sufficiently. U.S. stocks reacted positively, continuing to reach new highs, while U.S. bond yields and the dollar notably declined. From both a mid-term and short-term perspective, the Fed's position remains uncertain, potentially intensifying market volatility, where “good news” in macroeconomic data could turn into “bad news” for the market.

The Federal Reserve's decision-making and market reactions

The Federal Reserve expressed a moderation in inflation concerns in its meeting minutes. Despite an upward revision in the 2024 PCE forecast, the assessment of inflation has shifted from “lack of further progress” in May to “mild improvement.” Regarding rate cuts, while the dot plot indicates that rate cuts remain the consensus view, there is significant disagreement, particularly concerning the magnitude of the cuts. The June dot plot indicates a moderate improvement in inflation according to the U.S. CPI report, but options for three or more rate cuts have been ruled out, with the Fed still expecting only one rate cut this year.

From the perspectives of fundamental comparison, policy intent, and policy thresholds, current fundamentals may not be comparable to those of September 2023. Although the median rate level in the June dot plot is similar to last September's, current economic growth and inflation conditions are weaker than last year's. The Fed may aim to avoid the pitfalls of prematurely celebrating as last year, extending the observation window from three months to four to six months to confirm sustained improvement in inflation.

The Federal Reserve's rate cut threshold and market expectations

Federal Reserve Chairman Powell stated in a press conference that despite signs of improved inflation readings, the Fed is not eager to cut rates. He emphasized that further positive data is needed to justify a rate reduction. This stance contrasts sharply with market reactions, especially as investor expectations for a September rate cut have risen following reports of easing price pressures.

However, Fed officials' forecasts may already seem outdated, as they submitted new rate projections over the weekend and revised them before the Wednesday meeting. Powell described the inflation forecasts underlying these rate projections as “conservative,” reflecting officials' cautious approach in constructing inflation models.

Economic Data and Market Dynamics

Despite the Federal Reserve's most rapid interest rate hikes in decades in 2022 and 2023, many economists are amazed at how the economy has weathered these increases. Fed officials are reluctant to cut rates without more evidence that their policy stance is restrictive, yet they also fear it may be too late to avoid a sharp rise in unemployment once they see such evidence.

Ahead of the July policy meeting, Fed officials will receive an inflation report, followed by three monthly reports before the mid-September meeting. The September meeting will be the Fed's last before the U.S. elections on November 5, adding to market scrutiny of Fed decisions.

Conclusion

The Federal Reserve‘s decision-making process is fraught with contradictions and uncertainties. Despite the market’s positive response to improved inflation data, Federal Reserve officials remain cautious about cutting interest rates. They require more data to confirm sustained improvements in inflation while avoiding potential negative consequences of premature rate cuts. During this process, market volatility may intensify, necessitating close attention from investors to Federal Reserve policy directions and changes in economic data.