CICC: The Federal Reserve will not preemptively cut interest rates; the future path of interest rate cuts will depend on tariff negotiations

According to the Zhitong Finance APP, CICC released a research report stating that the Federal Reserve's decision to hold steady at the May meeting aligns with market expectations. The monetary policy statement pointed out that the risks of rising unemployment and increasing inflation have both intensified, suggesting that the policy environment faces the risk of "stagflation." However, due to the current robust economic data, the Federal Reserve is not in a hurry to act. CICC believes that the Federal Reserve will not cut interest rates in the short term, especially not preemptively, and the future path of rate cuts will depend on tariff negotiations: if negotiations do not make substantial progress and tariffs remain high, the Federal Reserve may be forced to initiate "recession-style" rate cuts, potentially lowering rates by 100 basis points before the end of the year; but if negotiations yield effective results and tariffs decrease, the Federal Reserve may delay rate cuts until December, with a more moderate reduction.

CICC's views are as follows:

Since this meeting did not include a new dot plot or economic forecast table, the monetary policy statement became the only document. The statement clearly indicated that the committee is attentive to the risks on both sides of its dual mandate and judges that the risks of higher unemployment and higher inflation have risen (The Committee is attentive to the risks to both sides of its dual mandate and judges that the risks of higher unemployment and higher inflation have risen). This wording reflects that the Federal Reserve has recognized the current policy environment faces the risk of "stagflation," where economic growth may slow while prices rise.

However, Powell sent a more cautious signal at the subsequent press conference. He pointed out that despite the rising risks, economic data has not shown significant signs of deterioration. The labor market remains robust, and the unemployment rate is still low; although the first-quarter GDP data was weak, consumer spending and business investment are still expanding; consumer inflation expectations are rising, but actual inflation data has not shown significant increases. In other words, there is currently not enough data to prompt the Federal Reserve to act quickly, and the future evolution of the economy is highly uncertain. Based on the current situation, Powell emphasized that "policy is still well-positioned" and is not in a hurry to adjust policy, stating that the Federal Reserve will remain patient and continue to watch for changes in data (wait-and-see).

CICC believes that Powell's statements mean the Federal Reserve will not cut interest rates in the short term, especially not preemptively. In other words, as inflation may have upward risks due to tariffs, the Federal Reserve's ability to support the economy is constrained. This situation is different from the period of U.S.-China trade friction during Trump's first term in 2019, when the Federal Reserve was able to "easily" cut rates three times in response to a slowing economy and low inflation. CICC believes that the current environment does not allow the Federal Reserve to take preemptive actions, and the correct approach for decision-makers is to wait for the situation to become clearer.

Of course, this also brings a potential risk: the Federal Reserve's monetary policy may be "behind the curve." Due to the lagging nature of economic data, waiting for clear signs of economic growth and labor market slowdown to appear in the data before initiating rate cuts may result in missing the optimal timing However, in the current context, the Federal Reserve indeed has no better options. Faced with negative supply shocks triggered by tariffs, hastily easing policy could raise inflation and exacerbate risks. The Federal Reserve can only prioritize ensuring that inflation does not pose a risk, choosing a policy path with relatively smaller losses.

Regarding the future path of monetary policy, CICC believes it will depend on tariff negotiations. CICC maintains its previous two scenario forecasts: the first scenario is that trade negotiations do not make substantial progress, and tariffs remain high after the 90-day suspension period. This will significantly suppress consumption and business investment, dragging the economy down and potentially leading to a recession. CICC expects that in this scenario, the Federal Reserve may be forced to initiate "recessionary" rate cuts, with a reduction of up to 100 basis points within the year.

The second scenario is that trade negotiations achieve effective results, and the demand shock to the U.S. economy will ease in the short term, but inflationary pressures may persist for a while. CICC expects that in this case, the Federal Reserve will delay rate cuts, with the first rate cut potentially postponed until December, and the magnitude will also be more moderate.

Due to the high uncertainty surrounding tariff negotiations, which scenario will ultimately materialize remains to be seen. However, overall, the unpredictable nature of Trump's policies and the rising "stagflation" risks faced by the U.S., along with the Federal Reserve's choice of a "wait-and-see, non-proactive rate cut" policy stance, create a macro environment that is not friendly to the capital markets