CITIC Securities Co., Ltd.: It is expected that the Federal Reserve will cut interest rates no more than 2 times this year, and the market may continue to trade around Trump's tariff policy in the short term

According to the Zhitong Finance APP, CITIC Securities released a research report stating that at the Federal Reserve's monetary policy meeting in May 2025, the policy interest rate was kept unchanged, and the meeting statement emphasized that "uncertainty has further increased." Powell's remarks revolved around the words "uncertain" and "watch and see," seemingly providing almost no incremental information. However, based on CITIC Securities' analysis framework of "transitory inflation + weaker growth + high uncertainty," current U.S. economic data and inflation expectations have somewhat reduced the expectations for interest rate cuts. The institution still expects the Federal Reserve to cut rates no more than or equal to 2 times within the year and anticipates that the June Federal Reserve meeting will maintain the policy interest rate unchanged.

In the market, the lackluster meeting did not stir much turbulence. CITIC Securities expects the market to continue trading around Trump's tariff policy in the short term, with bearish sentiment on the dollar remaining strong in the foreign exchange market. The outlook for U.S. stocks remains unclear, and high volatility is expected to persist in the short term.

CITIC Securities' main points are as follows:

Key points from the May 2025 Federal Reserve meeting statement:

1. In terms of interest rate tools, the committee decided to keep the target range for the federal funds rate unchanged at 4.25-4.5%, in line with market expectations, and this interest rate decision received unanimous agreement from FOMC members.

2. Regarding the balance sheet, the committee maintained the pace of balance sheet reduction, with a monthly redemption cap of $5 billion for U.S. Treasury securities and a monthly redemption cap of $35 billion for agency debt and MBS.

3. On the economic outlook, although net export fluctuations affected the data, recent indicators show that economic activity continues to expand steadily. The unemployment rate has remained stable at a low level in recent months, and the labor market remains robust. The inflation rate is still slightly high. The committee aims to achieve full employment and a 2% inflation rate in the long term. The uncertainty surrounding the economic outlook has further increased. The committee is closely monitoring the risks to its dual mandate and assesses that the risks of rising unemployment and inflation have increased.

The May 2025 Federal Reserve meeting statement emphasizes "increased uncertainty," with the main changes including:

1. The statement added "despite net export fluctuations affecting the data"; 2) The statement changed "the uncertainty of the economic outlook has increased" to "the uncertainty of the economic outlook has further intensified"; 3) The statement added "the assessment that the risks of rising unemployment and inflation have increased."

Powell's remarks revolved around the words "uncertain" and "watch and see," with almost no incremental information.

Regarding the economic situation, Powell reviewed the Q1 U.S. GDP data and recent non-farm data, stating that U.S. domestic demand (PDFP, Private Domestic Final Purchases) remains resilient, and the job market is still generally balanced. Looking ahead, Powell indicated that the economic outlook is highly uncertain (Powell stated his intuition is "uncertainty is extremely elevated"), and he still cannot determine which risk will materialize first: inflation pressures or economic growth pressures. Regarding how to weigh between the two, Powell did not specify at what level of inflation or unemployment the interest rate policy would respond, only roughly indicating that when one significantly deviates from the target, the Federal Reserve's interest rate policy would tilt towards it In terms of interest rate policy, "wait and see" is the only response from Powell, who also stated that the current inflation environment does not resemble the "preemptive" rate cuts of 2019.

Although Powell's remarks seem to lack significant incremental information, based on CITIC Securities' analysis framework of "transitory inflation + weaker growth + high uncertainty," the current U.S. economic data and inflation expectations have led to a reduction in rate cut expectations. It is still anticipated that the Federal Reserve will cut rates no more than twice this year, and it is expected that the June Federal Reserve meeting will maintain interest rates unchanged.

In the absence of highlights from this meeting, the framework previously proposed by CITIC Securities in "Commentary on the Federal Reserve's March 2025 Meeting - The Federal Reserve 'Wait for greater clarity'" (2025-3-20) remains applicable: the combination of "transitory inflation + weaker growth + high uncertainty" corresponds to the two rate cuts indicated in the March dot plot, and any reverse change in any of the three factors theoretically would lead to a reduction in the number of rate cuts.

First, "transitory inflation" is the most obvious change after tariffs, and Powell's softening stance on "transitory inflation" corresponds to a reduction in rate cut expectations. The "transitory inflation" narrative resurfaced at the March meeting, but from Powell's remarks on April 16, it is evident that the "transitory inflation" view has changed; he stated at that time that "the inflation effects could also be more persistent." In this press conference, his confidence in the "transitory inflation" narrative is weaker, indicating that the inflation situation will depend on factors such as the scale of tariffs and the time it takes for tariffs to pass through to prices. (The effects on inflation could be short-lived—reflecting a one-time shift in the price level. It is also possible that the inflationary effects could instead be more persistent. Avoiding that outcome will depend on the size of the tariff effects, on how long it takes for them to pass through fully into prices, and, ultimately, on keeping longer-term inflation expectations well anchored.) Second, regarding "weaker growth," Powell expressed greater concern for hard data, while the market has been worried about soft data. As mentioned earlier, the probability of a "preventive" rate cut similar to that in 2019 is currently very low, and the weakening of soft data is unlikely to have a significant impact on the Federal Reserve's interest rate policy. The market's focus on "weaker growth" needs to shift more from soft data to hard data, even though the release of hard data is delayed. CITIC Securities mentioned in the report "2025 May Day Holiday U.S. Economic Data and Market Dynamics Review—Optimistic Expectations for Tariff Negotiations Boost Asian Currencies" (20250505) that during the May Day holiday, U.S. economic data (25Q1 GDP, April non-farm payrolls, April manufacturing PMI) was overall robust, and the market seemed to realize that the "weaker growth" expectations mentioned in the March SEP were sufficiently poor, while the current economic data is better than that expectation, which also corresponds to a reduction in rate cut expectations.

Third, "high uncertainty" still persists, but with Trump beginning trade negotiations with other countries, the uncertainty has marginally decreased in the short term, which also corresponds to a reduction in rate cut expectations.

Market aspect, the bland meeting did not stir much turbulence, and it is expected that the market will continue to trade around Trump's tariff policy in the short term. In the foreign exchange market, bearish sentiment towards the dollar remains strong, and the outlook for U.S. stocks is still unclear, with expectations of high volatility in the short term.

Powell's remarks were almost identical to those made on April 16, and the market did not show the intense reaction seen on April 16 again. After Powell's speech, the Nasdaq rose by 0.27%, the S&P 500 rose by 0.43%, the Dow Jones rose by 0.70%, the 10Y U.S. Treasury yield fell by 2.52bps, the 2Y U.S. Treasury yield fell by 0.41bps, and the dollar index rose close to the 100 level. In the absence of incremental information from the Federal Reserve, it is expected that the market will continue to trade around Trump's tariff policy in the short term. In the foreign exchange market, although current U.S. economic data remains resilient, the bearish sentiment towards the dollar still dominates under the impact of tariff policies. Although U.S. stocks have rebounded recently, the outlook remains unclear, and high volatility is expected to continue in the short term.

Risk factors:

U.S. inflation rebounds beyond expectations; U.S. labor market weakens beyond expectations; Trump implements interventions in the Federal Reserve's independence beyond expectations; Trump's tariff policy exceeds expectations