CICC: Delays Federal Reserve interest rate cut forecast to the fourth quarter

According to the Zhitong Finance APP, CICC released a research report stating that after the Sino-US Geneva talks, both sides significantly reduced tariffs, and the risk of a US economic recession has decreased. However, the effective tax rate of 15.5% is still significantly higher than last year's 2.4%, and inflation risks have not been completely alleviated. Historical experience shows that price increases generally occur 2-3 months after the full implementation of tariffs, and the latest inflation data cannot yet reflect this. The bank believes that the easing of tariffs will reduce the Federal Reserve's concerns about employment (recession), thereby placing more emphasis on inflation risks, which means the Federal Reserve may continue to wait for clearer inflation data. CICC has postponed its forecast for the Fed's interest rate cut to the fourth quarter (previously the third quarter) and expects the rate cut this year to be less than 50 basis points.

CICC's main points are as follows:

The risk of a US economic recession has decreased

After the Sino-US Geneva talks, both sides agreed to reduce tariffs. The bank's calculations show that under the latest policy, the effective tariff rate in the US will decrease from the previous 28.4% to 15.5%, significantly reducing the risk of recession. The reduction in tariffs alleviates the pressure of sharply rising import costs for US goods, restores consumer confidence, and reduces the risk of corporate layoffs and bankruptcies, helping to stabilize overall economic demand. In addition, the reduction in tariffs has also boosted market risk appetite, leading to a significant rebound in global stock markets, which helps to ease the financial market volatility caused by the escalation of trade frictions and high uncertainty.

However, the 15.5% rate is still significantly higher than last year's 2.4%. Under the latest tariff policy, a 10% baseline tariff still exists for most countries globally, and this retained tariff will continue to suppress growth as a supply shock. The bank's calculations indicate that under the new tariff levels implemented according to the agreement, the US's real GDP growth rate in 2025 may decline by an additional 0.73 percentage points compared to a scenario without tariffs, a reduction that is significantly narrower than the 1.4 percentage point impact before the tariff reductions. Simply referencing historical experience with Okun's Law, a decline in GDP growth is accompanied by an increase in the unemployment rate, and the latest tariffs may correspond to an additional increase of 0.5 percentage points in the unemployment rate for the entire year of 2025. Since the labor supply in 2025 will not be as abundant as in previous years when there was a large influx of immigrants, the increase in the unemployment rate may be slightly smaller, but the number of new jobs will decline as the economy slows, and the labor market will still show signs of slowing down.

Inflation risks have not been completely alleviated

Due to the tax rate still being higher than last year, coupled with the depreciation of the dollar, US imported goods still face price increase pressures. With the implementation of reciprocal tariffs, US federal tariff revenues surged in April, which also means that businesses or residents will still bear the cost of tariffs. Although the latest US CPI inflation data for April was below market expectations, this was mainly due to a weakening in service prices (especially airfares), while some commodity prices still showed signs of increase. For example, the price of entertainment goods rose by 0.4%, with audio equipment prices soaring by 8.8%, photography equipment prices rising by 2.2%, furniture and bedding prices increasing by 1.5%, and appliances rising by 0.8%.

In addition, because businesses previously imported some inventory in advance, inflation may manifest with a lag. On a micro level, there are also examples, such as Hyundai Motor in South Korea stating that to reduce the disturbance of tariffs on consumers, it will maintain current prices unchanged until June 2 Ultimately, companies will still pass on costs to consumers. The Dallas Federal Reserve's April manufacturing survey shows that 75% of surveyed manufacturers plan to pass tariff costs onto consumers, with more than half hoping to pass down most or even all of the tariff costs.

Referring to the experience of 2018, price increases generally occur 2-3 months after tariffs are fully implemented, which means the latest inflation data cannot yet reflect this. The bank expects that under the current tariffs, prices of imported goods in the U.S. will still rise in the summer, which will cause the year-on-year growth rate of core CPI at the end of the second, third, and fourth quarters to reach 3.1%, 3.4%, and 3.8%, respectively. This also means that the inflation rate in April may be the low point for the year.

The Federal Reserve currently places more emphasis on inflation

The Federal Reserve's two government goals are 2% inflation and full employment. After the U.S.-China tariff reductions, the risk of recession has decreased, but the risk of inflation has not been completely eliminated, which will force the Federal Reserve to continue to wait and see. At the May FOMC press conference, Federal Reserve Chairman Jerome Powell stated there is no rush to cut interest rates and that more certainty in trade policy is needed. He mentioned the word "wait" 22 times in his speech and clearly stated that there would be no preemptive rate cuts. This indicates that decision-makers are unlikely to take action to cut rates without seeing clear data that proves inflation is consistently slowing. New York Federal Reserve President and permanent voting member John Williams also sent a hawkish signal, stating that discussions about preemptive rate cuts are "misplaced," and other officials have recently expressed similar cautious views on rate cuts.

The bank has postponed its prediction for the Federal Reserve's rate cut to the fourth quarter. Previously, the bank believed that if negotiations did not progress and tariffs remained high, it would put tremendous pressure on U.S. economic growth, potentially leading to a recession. In this scenario, the Federal Reserve might be forced to take "recession-style" rate cuts, cumulatively cutting rates by 100 basis points starting in the third quarter. However, the current situation is that negotiations have made substantial progress, and tariffs have been reduced, so the Federal Reserve will also delay rate cuts. The bank expects rate cuts to begin in the fourth quarter, with the total cut for the year being less than 50 basis points.

Forecast Risks: Policy Fluctuations and Weak Demand

The bank mentioned two risks in its forecast. One is that tariff policies may change again, exacerbating the Federal Reserve's concerns about slowing employment. Currently, the U.S. has only suspended some tariff measures, and whether they can be completely canceled still depends on negotiations. If tariffs "return" after the suspension period, it could bring a "second shock" to the U.S. economy, reigniting market recession fears, worsening risk appetite, and potentially triggering a new round of "bad news" rate cut trades.

The other risk is weak demand leading to declines in oil prices and service inflation, offsetting the "imported" inflation pressure brought by tariffs. Recently, global crude oil prices have significantly retreated, influenced by concerns over weakening global demand and supply pressures from OPEC's production increase expectations. If oil prices decline further, it may provide more relief for global inflation. Additionally, weak service consumption this year has led to lower prices for services such as airfares and hotels, helping to lower overall inflation levels. Another point of concern is the changes in drug prices On May 12, 2025, Trump signed an executive order announcing the implementation of the "Most-Favored-Nation Policy," requiring U.S. prescription drug prices to be reduced to the lowest levels globally. Trump claimed that U.S. drug prices would decrease by 50% to 90%. This initiative may exert downward pressure on medical inflation, but the specific impact remains to be observed.

Chart 1: The latest effective tariff rate in the U.S. will drop from the previous 28.4% to 15.5%

Note: 1900-1918 and 2024 are U.S. government fiscal years, 1919-2023 are calendar years, and 2025 is an estimate by the author.

Source: USITC, Wind, CICC Research Department

Chart 2: U.S. fiscal April tariff revenue surged significantly

Source: Haver, CICC Research Department

Chart 3: Rising cost pressures on manufacturers and willingness to pass on prices

Source: Haver, CICC Research Department

Chart 4: Retailers' inventory on hand can support approximately 1-2 months of sales