【MACRO Alert】A Multidimensional Perspective on U.S. Economic Policy - The Interweaving Strategies of the Treasury and the Federal Reserve

The U.S. economic policy has always been a focal point in the global economic arena. Recently, the firm stance of U.S. Treasury Secretary Janet Yellen, the critical voice of former President Donald Trump, and market expectations for the Federal Reserve's monetary policy have painted a complex picture of economic policy.

Secretary Yellen has strongly refuted accusations by “Dr. Doom” Nouriel Roubini, who accused the Treasury of manipulating bond issuance to reduce costs. Yellen stated in an interview that Roubini's arguments, published in a paper on Tuesday, “implied a strategy aimed at easing financial conditions. I can assure you, 100% there is no such strategy, and we have never discussed anything like that.” Treasury official Joshua Frost, who oversees debt issuance, also emphasized that the Treasury's actions are within the expectations of market participants.

Yellen also countered Trump's view that a strong dollar harms manufacturers. Yellen has always adhered to the G7's long-term commitment to market-determined exchange rates. She said in an interview last week that the impact of a strong dollar should be viewed from a broader perspective. She also downplayed the role of international trade in reducing U.S. factory jobs. Yellen stated that the bills signed by President Biden to strengthen infrastructure, semiconductors, and clean energy, along with electric vehicle policies introduced through the Inflation Reduction Act, provide support for the manufacturing industry to offset the strong dollar.

Meanwhile, the market expects the Federal Reserve to start gradually cutting interest rates from September to address potential economic downturn risks. Bond traders have prepared for the gradual rate cuts starting in September, increasing their bets to prevent a sudden economic downturn that could force the Federal Reserve to take more aggressive actions. With U.S. Treasury bonds rising for the third consecutive month, investors have fully priced in at least two rate cuts of 25 basis points this year, which is slightly higher than the forecasts of Federal Reserve policymakers.

When considering interest rate cuts, Federal Reserve officials must weigh inflation and the development of the labor market. The decline in inflation and signs of cooling in the labor market have made officials increasingly worried that waiting too long could lead to a failed economic soft landing. Federal Reserve Chairman Jerome Powell emphasized that reducing inflation to the 2% target while maintaining a healthy labor market is the primary task. In June this year, the U.S. unemployment rate rose from 3.7% at the end of last year to 4.1%, mainly due to slower recruitment and the longer time it takes for new employees or those re-entering the labor market to find jobs.

Despite the increasing possibility of a rate cut, one reason officials are unlikely to cut rates this time is that it may be the first cut in a series of rate adjustments. Officials have been surprised by inflation in the past and they hope to have more evidence that inflation is indeed cooling before crossing the threshold for a rate cut. New York Federal Reserve Chairman John Williams suggested that there is no need to cut rates in July, saying that officials will “learn a lot between July and September,” and pointed out that recent economic activity has been robust.

In terms of inflation, a potential inflation indicator that excludes food and energy prices fell to 2.6% in June, lower than the 4.3% a year ago and the peak of 5.6% two years ago. Williams pointed out that this decline is widespread, and he refuted the concern that it will be exceptionally difficult to bring interest rates back to the Federal Reserve's 2% target. Williams said, “This is not a story about the 'last mile' or some particularly tricky part. Different inflation indicators are all moving in the right direction and are quite consistent.”

In terms of the labor market, Federal Reserve Governor Christopher Waller said in a recent speech, “Currently, the labor market is in the best position.” Waller is one of the most active advocates of this argument. He said, “We need to keep the labor market in this best position.” The same analysis also predicts that the cooling of the labor market will only last for a period, and at some point, the traditional trade-off between the reduction of labor demand and the rise in unemployment will return. Former Federal Reserve Vice Chairman Richard Clarida said, “If you really go so far along a path that is considered very, very bold and deviates from the consensus, then yes, you want to stick the landing.” This indicates that the Federal Reserve may adopt a more cautious strategy when weighing the risks of inflation and rising unemployment rates.

The market is extremely sensitive to the Federal Reserve's policy expectations. Comments from former New York Federal Reserve Chairman William Dudley and Mohamed El-Erian are enough to cause market turmoil. Traders have already begun to use options to prepare for their investment prospects, betting on rate cuts starting as early as July. Nevertheless, data on unemployment claims, U.S. economic growth, and consumer spending still help support the Federal Reserve's decision to stand pat this week.

Jack McIntyre, portfolio manager at Brandywine Global Investment Management, said, “If there are more signs of weakness in the labor force, then the economic situation will be worse, which would lead the Federal Reserve to intensify the rate cut. What we don't know is what kind of rate cut cycle this will be.” This shows that market participants are highly attentive to the Federal Reserve's decisions and the future direction of the economy.

The dynamics of U.S. economic policy are complex and changeable. Yellen's firm stance, Trump's different perspective, the Federal Reserve officials' expectations for rate cuts, and the market's sensitive reaction together form the current panorama of U.S. economic policy. As economic data continues to be updated and policymakers continue to assess, we can expect that U.S. economic policy will continue to occupy a central position in global economic discussions.