China Galaxy Securities: When will the Federal Reserve start the next rate cut?

According to the Zhitong Finance APP, China Galaxy Securities released a research report stating that due to the hawkish expectation management at the December FOMC meeting and the arrival of uncertainty surrounding Trump, there were no significant surprises at the January FOMC. The Federal Reserve is likely to continue observing changes in economic data in the short term, as well as the scale and impact of the Trump administration's policies, in order to find opportunities for further moderate rate cuts within the year. The judgment that a rate cut of 50-75 basis points is expected in 2025 remains unchanged, with the first rate cut in 2025 possibly occurring in the second quarter.

The main points from China Galaxy Securities are as follows:

After the hawkish expectation management by the Federal Reserve in December, it paused rate cuts as expected, with limited incremental information: On January 29, the Federal Reserve announced at the FOMC meeting to keep the federal funds rate unchanged and continue to reduce its balance sheet, maintaining the interest rate level at 4.25%-4.50%, which is basically in line with market expectations. Due to the hawkish expectation management at the December FOMC meeting and the arrival of uncertainty surrounding Trump, there were no significant surprises at the January FOMC. The Federal Reserve is likely to continue observing changes in economic data in the short term, as well as the scale and impact of the Trump administration's policies, in order to find opportunities for further moderate rate cuts within the year. The judgment that a rate cut of 50-75 basis points is expected in 2025 remains unchanged, with the first rate cut in 2025 possibly occurring in the second quarter.

The assessment of the labor market and inflation in the FOMC statement appeared to be unexpectedly hawkish, but Powell explained in the press conference that the wording adjustment was merely to simplify language, with no special guiding direction: The description of the labor market was modified from "employment growth has slowed since the beginning of the year but remains strong, and the unemployment rate remains low" in December to "the unemployment rate has stabilized at a low level in recent months"; the statement on inflation was changed from "inflation has eased over the past year" to "inflation remains relatively high." The modified wording seems more hawkish, suggesting that there is no need for rate cuts given the low unemployment rate, while also not emphasizing that inflation has eased. After the statement was released, the market initially interpreted it as the Federal Reserve further signaling hawkishness, leading to an increase in U.S. Treasury yields and the dollar index. However, Powell later explained in the press conference that the wording adjustment was merely a language cleanup and stated that the labor market and inflation data before the meeting were relatively in line with the 2% target, indicating that the adjustment was not meant to release new signals, which clearly alleviated market concerns about the Federal Reserve further turning hawkish. This pause in rate cuts is merely a continuation of the hawkish expectation management from December, and the Federal Reserve has not shown dissatisfaction with the process of inflation decline, but has chosen to further observe due to concerns about Trump-related uncertainties.

The Federal Reserve is currently not in a hurry to cut rates in March, and is likely to remain inactive in the first quarter, observing the impact of Trump’s influence on the data: In response to a reporter's question, Powell stated that the general view of the monetary policy committee is that "we don’t need to be in a hurry to adjust our policy stance." This seems to indicate that the Federal Reserve is inclined to keep interest rates unchanged in the first quarter and wait for changes in policies and data Market liquidity levels remain sufficient, and the Federal Reserve is inclined to continue quantitative tightening for a while longer: In response to questions about quantitative tightening (QT), Powell read a prepared statement, stating that recent data shows liquidity remains abundant, with reserve levels nearly as high as before the balance sheet reduction began, and the federal funds rate remains stable within the target range. Overall, the Federal Reserve currently assesses that liquidity can still support the continuation of balance sheet reduction for some time, and we believe that signals for further adjustments to balance sheet reduction may not come until at least mid-2025.

The Federal Reserve is satisfied with the process of inflation retreating and will not raise the 2% inflation target: Powell still believes that recent inflation data shows signs of moving towards 2% and stated that short-term better or worse data should not be over-interpreted. Regarding whether the 2% inflation target will be adjusted, Powell firmly stated that no committee member is interested in adjusting the inflation target: “If I’m being at all unclear, we are not going to change the inflation goal.”

The market continues to fluctuate in uncertainty while waiting: CME data shows that federal funds rate futures traders generally maintain expectations for interest rate cuts, anticipating two cuts in 2025. Although dollar assets experienced volatility due to wording adjustments, it ultimately turned out to be a "false alarm." The dollar index briefly rose to around 108.3 but ultimately closed at 107.9555; the yield on 10-year U.S. Treasuries briefly rose to 4.589% before retreating to 4.528%; the three major U.S. stock indices collectively closed lower; and London gold prices slightly declined to $2758.615 per ounce. Overall, the market is in a fluctuating state following a relatively calm January meeting. We still believe that the market currently overestimates the Trump administration's ability and impact regarding key policies such as tariffs and immigration control, corresponding to a tighter forecast for the Federal Reserve's interest rate cut path, leaving room for further adjustments in the future. In the short term, "increasing tariffs + controlling immigration + reducing deficits" may be difficult to advance quickly and significantly.

Regarding U.S. Treasury yields, the recent decline in the yield on 10-year U.S. Treasuries mainly reflects a slight rebound after the rapid compression of expectations for Federal Reserve interest rate cuts, while term premiums remain elevated due to short-term uncertainties and mid-term fiscal expansion concerns. Although it is difficult to determine whether yields have peaked in the short term, there are trading opportunities in long-end U.S. Treasuries this year, with 10-year U.S. Treasuries yielding 4.5%-4.6% still possessing allocation value and a high probability of success. In terms of the dollar index, the economic and interest rate differentials between the U.S. and other countries in the dollar index basket are unlikely to narrow significantly, supporting its continued strength. Regarding U.S. stocks, although valuations are high, there is currently no risk of a sustained significant correction given the solid fundamentals and corporate profit growth roughly in line with expectations, but technological developments related to AI narratives may cause short-term volatility Risk Warning: 1. The risk of the U.S. labor market and economic data exceeding expectations; 2. The risk of unexpected liquidity issues in the U.S. banking system; 3. The risk of Trump's policies unexpectedly stimulating inflation