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Fed’s Rate Cut Caution | skip to SGD/CNY
At their January policy meeting, most Fed officials expressed concerns about the potential risks of cutting rates too quickly, suggesting that these risks outweighed the dangers of maintaining high rates for an extended period. The minutes from the Federal Open Market Committee (FOMC) meeting on January 30-31 revealed ongoing worries among policymakers regarding the path of inflation. Some expressed concerns that the decline in inflation toward the 2% target might stall. These minutes underscored the Fed's desire for additional evidence indicating a consistent decline in inflation.
Overall, most Fed officials have expressed concerns about the option of "cutting interest rates earlier" and believe that the risk of this action is significantly higher than "continuing to keep interest rates high." This confirms the statement from the previous meeting that "it is not appropriate to lower the interest rate target range before there is greater confidence that the inflation rate will continue to move towards 2%."
The minutes indicated that policymakers continue to monitor inflation trends, with some expressing concerns that progress in slowing U.S. inflation toward the Federal Reserve's 2% target could stagnate. While most officials anticipate that borrowing costs will need to remain elevated for a period, the precise timing of the initial rate cut remains uncertain. A minority suggested that delaying interest rate cuts could pose risks to the economy.
The committee acknowledged that U.S. inflation remains elevated, despite describing progress in disinflation as 'solid' in the minutes. However, they also noted that certain factors contributing to this trend were deemed unique and temporary. With both upward and downward risks to inflation in sight, participants emphasized the need to 'carefully evaluate' forthcoming data to ascertain its implications for the longer-term trajectory.
Recently, numerous officials have demonstrated a cautious approach towards monetary easing, particularly following Powell's dismissal of rate cut expectations for March. Fed Governor Bowman emphasized last week that "now is not the time to cut interest rates." To avoid undermining the goal of achieving price stability, Federal Reserve Vice Chairman Philip Jefferson emphasized the need to be cautious about excessive interest rate cuts in response to falling inflation. In a presentation to the Peterson Institute for International Economics, Jefferson said, " We always need to keep in mind the danger of easing too much in response to improvements in the inflation picture."
Jefferson's status as vice chairman implies that his stance closely mirrors Powell's perspective. He expresses cautious optimism regarding the trajectory of declining inflation, suggesting that the Federal Reserve might delay interest rate cuts until later this year. This sentiment aligns with that of other Fed officials, who have emphasized their reluctance to initiate rate cuts presently.
Jefferson identifies three primary risks to the economic outlook. Firstly, consumer spending might exhibit even greater resilience than currently anticipated, potentially stalling progress on inflation. Secondly, employment could weaken as the factors bolstering economic growth diminish. Thirdly, the escalation of conflicts in the Middle East could disrupt oil and other commodity markets.
The employment situation report released at the beginning of this month showed that non-farm employment in the United States increased by 353,000 people in January, the highest increase since January 2023. In addition, with CPI and PPI also stronger than expected, the urgency for rate reductions by the Federal Reserve remains subdued as they transition from signaling to implementing interest rate cuts.
At this economic cycle, the rate cut is noted not to be recession-driven, emphasizing a gradual and methodical approach rather than swift and deep cuts. The Fed aims for a soft landing, though with no guarantees, as the 'last mile' of disinflation can bring unpredictable fluctuations. Premature rate cuts could disrupt the downward inflation trend and increase policy volatility, necessitating a cautious stance and further data observation. In the baseline scenario, the Fed is expected to implement its first rate cut in mid-2024, with the pace of subsequent reductions remaining uncertain.
The decision hinges significantly on the core Personal Consumption Expenditures (PCE) figure, esteemed as the Federal Reserve's favored gauge for inflation. Ideally, the core PCE (6-month annualized) should be approximately 2%. Over the past year, we've witnessed a consistent deceleration trend in the six-month moving average of the core PCE, fluctuating between 0.2% and 0.3%. The forthcoming highlight of this week is the unveiling of the core PCE price index on February 29, anticipated to captivate market attention. A downside surprise in core PCE could propel the USD downward once more. Conversely, an unexpected rise in core PCE might briefly impede the USD's descent and prompt a reconsideration of rate cut expectations.
All in all, we find ourselves embracing a Goldilocks narrative. In this scenario, debt growth, economic expansion, and inflation all align in a state that is neither excessively heated nor too tepid. Our perspective anticipates a synchronized global slowdown, although the likelihood of a recession or a hard landing in the U.S. during 2024 appears improbable.
China’s Loan Prime Rate Declines
Last week, the People's Bank of China (PBoC) authorized the National Interbank Funding Center to announce the first reduction of the loan market quoted interest rate (LPR) on February 20. As of February 20, 2024, the 1-year LPR stands at 3.45%, while the 5-year and above LPR is set at 3.95%. This updated LPR remains valid until the next release. Notably, the LPR over 5 years has seen a 25 basis points reduction from the previous quotation.
Currently, the LPR serves as the primary reference benchmark for loan interest rate pricing. Financial institutions typically base the interest rate pricing of corporate working capital loans on the one-year LPR, while medium and long-term corporate loans and personal housing loans mainly rely on the LPR of more than 5 years.
The significant decrease in the LPR for maturities exceeding five years this time will effectively contribute to a continued decline in comprehensive social financing costs, further strengthening financial support for the real economy. Moreover, as LPR with a term of over five years is linked to the interest rate of residential mortgage loans, a reduction in interest rates can lower the interest rates of existing mortgage loans, effectively decreasing residents' home purchase costs and enhancing their willingness to consume housing.
Since the LPR reform in August 2019, the LPR for maturities exceeding five years has experienced eight reductions, dropping from 4.85% to 3.95%, a total decrease of 90 basis points. Additionally, the 1-year LPR has seen ten reductions, decreasing from 4.31% to 3.45%, representing a decrease of 86 basis points.
The significant 25 basis point reduction in the LPR this time marks the largest cut in history, surpassing the previous record of 15 basis points. This substantial reduction is attributed to several factors. Firstly, weak demand persists in the current property market, with residents maintaining low expectations regarding leveraging for home purchases. Secondly, the decision to implement a sizable reduction at once aims to prevent the formation of market expectations suggesting further rate cuts in the near future, thereby averting a cautious approach to purchasing power.
It's worth noting that while the LPR adjustment has been made, immediate adjustments to residents' mortgage interest rates will not occur. Typically, mortgage interest rates are repriced on January 1 of each year or on the loan disbursement date, subject to varying bank policies. Consequently, existing mortgage loans will undergo a recalculation of interest rates based on the latest LPR quotation rate plus the agreed basis points outlined in the contract, with changes taking effect in the subsequent cycle.
The China Index Academy noted that since 2024, policies affecting both the supply and demand sides of the real estate sector have been consistently enforced. On the demand side, preceding the Spring Festival, major cities have gradually eased purchase restrictions. This adjustment signifies a clear signal: the property market policy for 2024 remains generally accommodative, with further cities expected to adapt policies according to their individual contexts.
On the supply side, January saw an acceleration in the establishment of local real estate financing coordination mechanisms. Regions actively reported whitelists of financing support projects, with banking and financial institutions also actively connecting. The latest disclosures from the five major state-owned banks reveal their connection with over 8,000 real estate financing whitelist projects, with project funds gradually being secured. This effort aims to ensure project delivery and stabilize corporate expectations, thereby bolstering the confidence of home buyers.
We believe that China requires additional policy stimulus to bolster confidence, which currently stands at a low point. The stability of confidence is crucial, particularly given ongoing concerns regarding the property sector, which remains a vulnerability. Despite implemented measures, a double dip appears likely this year. Regarding the People's Bank of China (PBoC), we commend its efforts in maintaining relative stability in the Chinese yuan (CNY) even though wider USD-CNY yields continue to weigh on the yuan. We eagerly await The Two Sessions, scheduled for March 4 and 5, where major policy directions will be unveiled during the annual meetings of the National People's Congress (NPC) and the National People's Political Consultative Conference (NPPCC).