Source: Hongguan Zhuojian

Authors: Zhuo Hong, Peng Huaying, Wang Han

Original Title: Fed Changes and Changes in Recession Trades – Fed Tracker Issue 14

Investment Points

Since May, U.S. bond yields have fallen as a whole, U.S. stocks have pulled back, and overseas markets have generally shown “recession trading.” Minutes of the May FOMC meeting were released this week, in which we believe:

The Fed’s overall attitude continued in the May minutes, and the market is still fully expecting a 50bp rate hike in June and July.

Minutes points: The economy is still relatively strong, the interest rate may be raised by 50bp several times in the future, and the balance sheet will be reduced in June. On the economic outlook, Fed officials believe the current economy is strong. Although GDP turned negative in the first quarter, GDP is expected to rebound in the second quarter and grow steadily throughout the year.
The market’s expectation of a 50bp rate hike in June and July has returned to more than 99%. In the week of May 16, with the adjustment of U.S. retail stocks, the market expectations for interest rate hikes in June and July declined. However, with the further disclosure of the first quarterly reports of U.S. listed companies recently, the market sentiment has been restored, and the current market expects that the probability of raising interest rates by 50bp in June and July is more than 99%.

Noteworthy marginal changes: some officials released pigeons, and the rate of interest rate hikes decreased after September.

In 2024, Bostic announced that it could consider suspending interest rate hikes in September. In an interview on May 23, the 2024 Fed voting committee Bostic said that after raising interest rates by 50bp in June and July, “it is reasonable to suspend interest rate hikes in September.” This is the first time since the Fed turned hawk last November that officials have made dovish remarks about pausing interest rate hikes.
Expectations of interest rate hikes for the year fell slightly, and the rate hikes for September and subsequent meetings are expected to decline. Current futures imply that the federal funds rate at the end of 2022 will fall by 10bp from last week, and the market expects a 241bp rate hike throughout the year. Market expectations for the rate hike in the September meeting and afterward have declined, with most market participants expecting a 25bp rate hike in September.
Economic data cooled, residents’ inflation expectations fell, and port data continued to improve. The University of Michigan’s consumer confidence index cooled rapidly, with residents’ one-year inflation expectations falling from the previous month. The number of ships waiting at berths and beyond at the ports of Los Angeles and Long Beach fell to 27 from 47 last month, as congestion at sea continued to signal improvements.

Earnings pressure on U.S. stocks is heating up, and under external constraints, the Fed’s room to remain hawkish continues to compress. At present, the ideal path for the Fed is to improve supply–inflation falls–the margin of monetary policy loosens–a soft landing for the U.S. economy. However, in the advancement of this path, the fault tolerance rate is actually relatively low. Looking back, the narrow policy space and the continuous accumulation of negative feedback on household consumption due to the continuous correction of the stock market will increase the external constraints of the Federal Reserve. If demand declines faster than supply repairs, the possibility of the Fed turning to easing in order to achieve a soft landing of the economy cannot be ruled out, and the focus can be on the third quarter.

Risk warning: U.S. inflation continued to exceed expectations, and the Fed tightened monetary policy more than expected.

‘Inflation-Fed Tightening’ Trail Tracker