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Fed Speaks Cool Rate Cuts Bet | skip to SGD/CNY
Last week saw a flurry of ‘Fedspeaks’, mostly hawkish, advocating for a delay in interest rate cuts until there's greater confidence in inflation dropping to 2%. They provided several justifications for holding off on immediate easing or aggressive measures.
Federal Reserve (Fed) Officials | Highlights of Fed Speaks Parade |
Cleveland Fed President Loretta Mester | “It would be a mistake to move rates down too soon or too quickly without sufficient evidence that inflation was on a sustainable and timely path back to 2%.” |
Minneapolis Fed President Neel Kashkari | “The Federal Reserve should likely reduce its policy rate two or three times this year based on the information on the economy currently in hand.”
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Boston Federal Reserve President Susan Collins | “For now, policy remains in a good position, and we are carefully evaluating the evolving data and outlook. As we become more confident...I think, It may be appropriate to start easing policy constraints later this year."
The strong performance of the labor market and the economy showed that it would take some time for the economy to cool down, and the beginning of interest rate cuts should be gradual. |
Richmond Fed President Thomas Barkin | "I'm a big proponent of being patient in getting where we need to be."
There's still a degree of uncertainty about inflation. I'm waiting for that to be clearer before announcing anything more about what we're doing in terms of policy. .” |
Fed Governor Adriana Kugler | “At some point, the continued cooling of inflation and labor markets may make it appropriate to reduce the target range for the federal funds rate.”
“On the other hand, if progress on disinflation stalls, it may be appropriate to hold the target range steady at its current level for longer to ensure continued progress on our dual mandate.” |
Philadelphia Fed President Patrick Harker | “The data point to continued disinflation, to labor markets coming into better balance, and to resilient consumer spending — three elements necessary for us to stick to the soft landing we remain optimistic to achieve.”
“Now certainly we haven’t touched down, and we’re going to have to keep our seatbelts on, but with inflation continuing to fall back to our 2% target, with employment remaining strong, and with consumer sentiment looking up, the runway at our destination is in sight.” |
These remarks from various Federal Reserve officials, often referred to as "Fedspeaks," echoed Federal Reserve Chairman Powell's stance from two weeks prior. Powell expressed doubt that there would be sufficient data available before the March meeting to demonstrate significant progress in addressing inflation, thus suggesting that an interest rate cut might not be warranted. Twice in recent weeks, Powell emphasized his skepticism that the Federal Reserve would have sufficient confidence in the inflation trajectory to warrant a rate cut at the March meeting.
The Federal Reserve has maintained interest rates at the same level since July of the previous year, with indications from several officials hinting that the next action may involve a rate cut. However, following the initial FOMC meeting in January of this year, numerous officials, including Powell, stressed the absence of urgency in reducing interest rates. Consequently, this shift in tone has led the market to revise its expectations for the timing of the first rate cut of the year from March to potentially May or June.
The urgency for rate reductions by the Federal Reserve remains subdued as they transition from signaling to implementing interest rate cuts. The core Personal Consumption Expenditures (PCE) figure remains pivotal for this decision, representing the Federal Reserve's preferred inflation metric. Ideally, the core PCE (6-month annualized) should hover around 2%. Over the past year, we've observed a consistent deceleration trend in the six-month moving average of the core PCE, ranging from 0.2% to 0.3%.
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 Deflationary Pressures
In December, the National Bureau of Statistics reported the fourth consecutive month of negative territory for the national Consumer Price Index (CPI), experiencing a year-on-year decline of 0.8%. This persistent trend underscores the deflationary risks facing the world's second-largest economy as it navigates post-pandemic recovery and subdued domestic demand challenges. Concurrently, the national Industrial Producer Price (PPI) recorded a year-on-year decrease of 2.5% and a month-on-month dip of 0.2% during the same period.
Deflation poses significant harm to the economy because it prompts individuals to anticipate long-term price declines, leading to deferred consumption. This decreased demand perpetuates a cycle where reduced consumer spending results in declining prices and corporate profits. In response, businesses scale back investments and may resort to layoffs, further reducing consumer income and spending. This creates a detrimental feedback loop of economic contraction.
Compared to combating inflation, controlling deflation poses greater challenges. Classic inflation theory suggests that inflation arises from an excess of money relative to goods, making it most effectively combatted by restricting the money supply. By demonstrating sufficient resolve and consistently raising interest rates, inflation can eventually be subdued. However, interest rate reductions present a different scenario, as the scope for lowering rates is constrained and typically bottoms out at zero. Few countries opt for prolonged periods of negative interest rates.
Even with interest rates reduced to a specific threshold, monetary policy might prove ineffective. Despite ongoing rate cuts, economic entities may not react accordingly. Take Japan, for instance, the pioneer of quantitative easing, which has kept interest rates at zero for an extended period. Despite these efforts, Japan has been unable to shake off the deflationary pressures lingering since the 1990s.
Judging from the history of deflation at home and abroad, it's evident that some instances of deflation are short-term phenomena that can be overcome through loose monetary and fiscal policies, ultimately stimulating economic growth. However, there are cases, like Japan, where deflation persists long-term despite various stimulus efforts. Thus, the question arises: Is the deflationary pressure China is currently facing short-term or long-term?
The current Chinese economy is technically experiencing deflation. However, a deeper concern lies in the underlying issue of weak demand driving low prices. Failure to address this challenge effectively could lead China down a path like Japan's economic struggles.
In Japan, long-term loose monetary policy has proved ineffective in tackling deflation. Despite the Bank of Japan injecting significant low-cost liquidity into the economy, Japanese companies have opted to prioritize debt repayment and reduce leverage instead of using the funds to expand investment. The lack of attractive investment opportunities has led to higher financial pressures outweighing the potential returns on investment for these companies. Consequently, monetary stimulus measures by the Bank of Japan have failed to incentivize increased investment by businesses, resulting in challenges in stimulating economic growth.
The current deflationary challenge in China is primarily rooted in domestic economic dynamics rather than external factors. Decades of rapid growth have exposed the underlying issue of insufficient demand, magnifying the urgency to address deflation. Simply relying on monetary and fiscal stimulus is no longer sufficient, given the already loose nature of existing policies. Persisting with such stimulus measures could risk falling into a liquidity trap and exacerbate adverse outcomes.
Japan's experience with deflation underscores the limitations of monetary stimulus, as the injected liquidity primarily went towards debt reduction rather than productive investment or consumption, leading to three decades of stagnation. Presently, China faces a comparable scenario: private sector investment remains tepid, evidenced by diminished real estate activity and pre-emptive mortgage repayments by residents. Rebuilding confidence among enterprises and the public is imperative for China to avert Japan's prolonged economic malaise.
Last week, financial markets were stirred by former U.S. President Donald Trump's suggestion of imposing a 60% tariff on China if he were to be re-elected in November. Trump's "America First" rhetoric and tough stance on China during his first term in the White House are well-known. The prospect of a potential Trump 2.0 administration engaging in a tariff war is understandably unsettling, raising questions about the feasibility of new business or investment plans in China amidst heightened tensions and uncertainty.