SINOLINK SECURITIES: Stagflation risk has significantly increased, and the Federal Reserve may find it difficult to restart the interest rate cut cycle

According to the Zhitong Finance APP, SINOLINK SECURITIES released a research report stating that the Federal Reserve will maintain the federal funds target interest rate range at 4.25%-4.50% during the June 2025 meeting, in line with market expectations. The marginal easing of "reciprocal tariffs" does not change the Federal Reserve's concerns about the risk of "stagflation," and the threshold for restarting the interest rate cut cycle in the short term is relatively high. The risk of rising inflation may be the Federal Reserve's highest priority concern in the medium term.

Investment Recommendations:

(1) Gold: Awaiting a "hard landing" in the U.S., gold prices will continue to reach new historical highs. Both a "hard landing" and "stagflation" in the U.S. are favorable for gold. Future driving forces include the trend of U.S. dollar depreciation, central bank gold purchases, the resumption of the Federal Reserve's interest rate cut cycle, and the "secondary pull" after the outflow of U.S. dollar liquidity.

(2) Pharmaceuticals (especially innovative drugs): Under the Federal Reserve's interest rate cut cycle, both A-shares and Hong Kong stocks in innovative drugs have opportunities for price increases and excess returns. In the short term, focus on policy guidance for improving gross margin expectations and the rebound of IRR as a "thematic investment." In the medium to long term, gross margins and revenue are expected to improve significantly, initiating a prosperous investment phase.

(3) U.S. Stocks: There is a significant potential adjustment risk. The risk of "stagflation" may put pressure on both the numerator and denominator of U.S. stocks. The marginal slowdown in capital expenditure expectations for tech giants also amplifies performance uncertainty, necessitating a reevaluation of valuation levels.

(4) U.S. Treasuries: This year, only waiting for inflation to decline can create a trend-based allocation opportunity. Before that, there may even be a possibility of interest rates rapidly rising due to interest repayment risks.

On June 18 local time, the Federal Reserve announced that it would maintain the federal funds target interest rate range at 4.25%-4.50%, marking the fourth consecutive "pause" since the current interest rate cut cycle began in September 2024. From September to December 2024, the Federal Reserve cut rates three times by 50/25/25 basis points, totaling 100 basis points.

The threshold for the Federal Reserve to restart the interest rate cut cycle is relatively high, and the economic forecast further reinforces the characteristics of "stagflation."

The Federal Reserve will maintain the federal funds target interest rate range at 4.25%-4.50% during the June 2025 meeting, in line with market expectations. Due to the potential impact of the "reciprocal tariffs" introduced by Trump, the Federal Reserve continues to "hold steady." The latest economic forecasts and dot plots further highlight concerns about potential "stagflation" risks. The main changes in this meeting's statement are: 1) changing "the uncertainty of the economic outlook has further increased" to "has decreased, but remains at a high level"; 2) removing the statement "that the risks of high unemployment and high inflation have both increased." These two changes mainly reflect the marginal easing of tariff levels since early April. In terms of economic forecasts and dot plots, the Federal Reserve has lowered growth forecasts and raised inflation and unemployment rate forecasts. The dot plot is "hawkish," with 1) the actual GDP growth rate forecast for 2025/26 revised down by 0.3 pct/0.2 pct to 1.4%/1.6%, and the core PCE forecast for 2025/26/27 revised up by 0.3 pct/0.2 pct/0.1 pct to 3.1%/2.4%/2.1%. The unemployment rate forecast for 2025/26/27 has been revised up by 0.1 pct/0.2 pct/0.1 pct to 4.5%/4.5%/4.4% 2) The dot plot maintains the forecast of two rate cuts in 2025, with the interest rate forecasts for 2026 and 2027 revised up by 0.2pct and 0.3pct respectively, corresponding to one rate cut each in the next two years. It is worth noting that among the 19 committee members, the number of those who believe that a rate cut is not necessary has increased from 4 in March to 7 in this meeting, supporting the hawkish tone of the interest rate guidance from this meeting.

The marginal easing of "reciprocal tariffs" does not change the Federal Reserve's concerns about the risk of "stagflation." The threshold for restarting the rate cut cycle in the short term is relatively high, and the risk of rising inflation may be the Federal Reserve's top priority in the medium term.

The key points from this meeting and press conference are as follows:

1. The impact of tariffs may begin to become apparent in the summer. Powell stated that although the Federal Reserve still cannot determine the specific final impact of tariffs, including scale, timing, and transmission speed, the trend of high tariffs pushing up inflation and putting pressure on economic activity is relatively certain, especially the rise in consumer prices for goods. This impact is expected to gradually become evident by summer. The main reason is that tariffs take some time to be transmitted to the final consumer (import prices converted to retail prices). The Federal Reserve expects that many companies will indeed pass on all or part of the tariff impact to the next person in the chain and ultimately to consumers.

2. Regarding monetary policy guidance, Powell admitted that "rate cuts may come quickly, or they may not come quickly." In addition to the inflation shock brought by tariffs, the Federal Reserve is also closely monitoring signs of strength or weakness in the labor market. If the current situation persists, "holding steady" is the correct approach. In other words, a further deterioration in the labor market and greater economic downward pressure may push the Federal Reserve to restart the rate cut cycle in the short term.

SINOLINK SECURITIES maintains the judgment that the Federal Reserve is currently in a "passive and difficult to take preemptive action" state. Beyond the hawkish tone of this meeting, SINOLINK SECURITIES even believes that: ① If Tariff 2.0 exacerbates the risk of "stagflation" in the U.S., the Federal Reserve may restart rate hikes, triggering a second round of "liquidity trap" shocks within the year; ② SINOLINK SECURITIES has consistently emphasized that U.S. "inflation" is a "legacy" of the 2020 QE, and its decline represents the "bubble" in U.S. residents' balance sheets being pierced. Therefore, when U.S. inflation begins to decline and the rate cut cycle fully commences, the market may also worry that the U.S. economy will shift from "stagflation" to "significant deflation," leading to a third round of "liquidity trap" shocks; ③ Following this, the marginal slowdown of the U.S. economic engine may be feared, as its growth may struggle to cope with debt interest, exposing risks in U.S. Treasuries, which will lead to the sale of most dollar assets including U.S. Treasuries, as the market competes for offshore dollars, triggering a fourth "liquidity trap."