A report by CYS Global Remit Payment Service Support Team
Powell's Pushback on March Rate Cut | skip to SGD/CNY
On the first interest rate decision of the year, last Thursday, the Federal Reserve (Fed) opted to unanimously maintain the interest rate range at 5.25%-5.50%, according to the Federal Open Market Committee (FOMC). A notable shift was observed in the FOMC statement, as it abandoned the longstanding mention of the potential for further interest rate hikes. Instead, the committee highlighted the necessity for increased confidence in inflation decline before considering interest rate cuts.
Federal Reserve Chairman Jerome Powell, in a press conference, mentioned that interest rates are nearing their peak, dismissing the likelihood of a rate cut in March. Consequently, U.S. stocks experienced a sharp decline during the session, while the USD and U.S. bond yields stabilized.
In this FOMC meeting, three key points demand attention. First and foremost, the Fed shows no urgency to implement interest rate cuts. The statement eliminated the phrase ‘additional policy firming that may be appropriate’ and, in its place, introduced 'any adjustments' to contemplate interest rates. This implies a shift towards policy normalization, suggesting that there will not be an interest rate cut in March.
Secondly, the Fed is seeking greater confidence in inflation data. While this meeting acknowledged that "inflation continues to ease," the Fed is cautious, especially considering that core inflation outside of housing has not yet shown sufficient evidence of a slowdown. The central bank suggests that it needs to witness a more pronounced downward trend in wage inflation to have the "confidence" that inflation will consistently return to the target of 2%
Thirdly, there is no immediate justification for early interest rate cuts based on financial risks. The recent significant improvement in financial conditions has alleviated the Fed's worries about its potential impact on the overall economy, leading to the complete omission of discussions on finance and credit during the meeting. Moreover, the statement highlighting the stability of U.S. banks was conspicuously absent, indicating that the risks associated with a sequence of regional bank failures last year have been effectively addressed.
At this point, we believe that the Fed still needs to transition from using interest rate policy language to formally implementing interest rate cuts, as the imperative for rate reductions is not currently pressing. The pivotal factor for rate cuts continues to be the core Personal Consumption Expenditures (PCE) figure, the Fed's favored inflation metric. Ideally, the core PCE (6-month annualized) should be in proximity to 2%. Observing the past year, the core PCE's six-month moving average has consistently demonstrated a steady deceleration trend, ranging from 0.2% to 0.3%
Given the recent focus on adjustments in the 3-month and 6-month core Personal Consumption Expenditures (PCE) by the Fed, we anticipate the potential for a mild rebound in the 6-month annualized core inflation in the United States during the first half of the year. It is expected to only regress to a level deemed satisfactory by the Fed in the middle of the year. Consequently, we posit that more time is required for the deceleration in core inflation to yield results that meet the Fed's criteria.
At this juncture, the firm anchoring of long-term inflation expectations becomes pivotal. The stability of this expectation serves as crucial evidence in determining whether the decline in inflation is transient or sustainable. Presently, both the Michigan survey and the New York Fed's median projections for future inflation exhibit a steady decline. If this trend persists, with expectations consistently staying below 3% and gradually converging toward the 2% threshold, it may contribute significantly to alleviating the Fed's concerns about losing control over long-term inflation expectations.
This, in turn, could facilitate a smoother initiation of discussions around potential interest rate cuts. However, it is essential to bear in mind that the Fed's decisions hinge on data dependency, remaining a fundamental factor shaping the timing of interest rate adjustments in 2024.
The market's anticipation of future interest rate cuts by the Fed is influenced by geopolitical developments, speeches from Fed officials, and economic fundamentals. These expectations can fluctuate, aligning closely or deviating from the Fed's own projections. To illustrate, following the December FOMC meeting last year, the market initially expected six interest rate cuts. Subsequently, due to geopolitical tensions, this expectation briefly rose to seven rate cuts.
In the past two weeks, the strengthening of expectations for a 'soft landing' in the U.S. economy, fueled by improved economic data, has resulted in a diminished anticipation of interest rate cuts. Current market expectations indicate that the Fed is likely to implement five interest rate cuts throughout the year, a figure that lags significantly behind the three cuts projected in the dot plot from December of the previous year. Looking ahead, we anticipate continued communication from Fed officials through interest rate policy language, aligning market expectations more closely with the Fed's outlook amidst the context of an economic 'soft landing'.
We anticipate short-term support for the USD index. The robust performance of the U.S. economy, coupled with a low risk of recession and a high likelihood of a 'soft landing,' reinforces the USD's economic fundamentals. Additionally, the European Central Bank (ECB) adopting a more dovish stance suggests that Europe may cut interest rates ahead of the US. This implies that even in the event of U.S. interest rate cuts, the US retains certain advantages over Europe. Furthermore, the current economic fundamentals of the U.S. outshine major non-U.S. economies, ensuring that the USD remains resilient despite policy changes.
Overall, 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 PMI Rebound
In January, China's official Purchasing Managers' Index (PMI) showed a slight rebound, reaching 49.2%, a 0.2 percentage point increase from the previous month. However, it remained below the boom-bust line and was weaker than historical comparisons for the same period.
Despite the marginal increase in PMI in January, the overall demand remains weak, and prices have declined, emerging as the primary factors limiting a more pronounced rebound in economic activity. In the absence of significant demand growth, the ex-factory prices of raw materials and products have dropped by 1.1 and 0.7 percentage points respectively from the previous month.
The production segment remains within the expansion range, with production activities experiencing further growth, albeit with a slackening demand side compared to the previous month. However, companies exhibit a lack of enthusiasm for hiring personnel, introducing potential uncertainty about the durability of the ongoing production upswing.
In January, the service industry experienced a rebound fueled by Spring Festival consumption. The overall non-manufacturing PMI increased to 50.7%, a level still considered low over the past five years. Notably, the service industry saw a rise of 0.8 percentage points to 50.1%, re-entering the expansion range after two months. Its new orders also improved by 0.7 percentage points month-on-month.
As the Lunar New Year approaches, there is a gradual increase in residents' demand for shopping and travel, elevating the prosperity of the service industry. The sector's expansion is evident across the industries surveyed, with 13 out of 21 now in the expansion range – a notable increase of 4 from the previous month. Primarily driven by holiday effects, retail, road transportation, air transportation, catering, and other industries have surged into the expansion territory.
The forthcoming emphasis lies in expanding domestic demand, prioritizing the restoration and expansion of private enterprise investment and household consumption. Simultaneously, efforts will be directed towards strengthening employment security through various measures to solidify the foundation for economic recovery.
In February, our focus will persist on monitoring the impact of monetary policy measures (such as the reduction in the required reserve ratio and the extension of the medium-term lending facility) and assessing the real-time economic data performance during the Spring Festival.
In the short term, we expect the USDCNY exchange rate to remain relatively stable. However, we are cautious of several factors that could favor USD strength. Firstly, the interest rate policy language of Fed officials is crucial in providing insights into the timing of potential interest rate cuts in 2024. This will impact U.S. long-term interest rates and the USD index. We believe both the 10-year U.S. Treasury bond interest rate and the USD index peaked last year, with the 10-year rate reaching around 5% and the USD index around 110. Secondly, we see global geopolitical conflicts as a potential upside risk for the USD index. Increased risk aversion among global investors due to geopolitical tensions could further bolster the USD index if conflicts escalate.