The April FOMC meeting concluded early this morning Beijing time, with the Federal Reserve holding steady as expected, keeping the benchmark interest rate unchanged at 3.5%-3.75%. With the Iran situation at a stalemate and oil prices remaining persistently high, CME interest rate futures have pushed back the expected timing of a rate cut to December 2027. Consequently, the rate decision itself was largely anticipated, with market focus instead on Chairman Powell's final statements and press conference as Fed Chair, and how he assessed the impact of the Iran situation.
The messaging from this meeting was neutral-to-hawkish. Firstly, while the statement retained wording about the possibility of future policy easing, the Fed saw its largest internal dissent since 1992, with four officials disagreeing with the statement. Secondly, although Kevin Warsh is poised to take over, Powell unusually stated he would remain on the Board of Governors until an investigation concerning him is concluded, adding to market concerns about future Fed divisions. Markets interpreted these developments cautiously. Combined with former President Trump's comments suggesting a potential extension of the Iran blockade, which pushed oil prices back above $110, these factors led to higher U.S. Treasury yields and a stronger U.S. dollar, while gold prices declined.
Core meeting takeaways: Rates were held steady, Iran-related risks were emphasized, internal divisions widened, and Powell is stepping down but not leaving.
The decision to maintain the benchmark rate at 3.5%-3.75% was fully anticipated. Following Powell's comments at the March FOMC that inflation's decline was less smooth than hoped and required further monitoring, U.S. CPI rose year-on-year to 3.3% in March from 2.4% in February. With U.S.-Iran negotiations still unresolved and Brent crude climbing back to $110 after Trump's remarks, alongside stronger-than-expected March non-farm payrolls, the urgency for rate cuts diminished.
The statement highlighted uncertainty from the Middle East situation but kept the door open for easing. It noted that inflation remains elevated and that the Middle East situation introduces a high level of uncertainty. However, it retained phrasing about potential "additional policy adjustments," a seemingly dovish tilt that nonetheless foreshadowed the internal dissent.
Fed internal dissent reached its highest level since 1992. Four officials dissented from the meeting's decision. A familiar dove continued to support a rate cut, while three others voted against the dovish hints in the statement, marking the largest split in three decades.
Warsh's succession is imminent, but Powell is staying on. Warsh successfully passed his nomination vote in the Senate Banking Committee, largely clearing the path for him to become the next Fed Chair. This was therefore Powell's final meeting and press conference as Chair. In a highly unusual move, Powell stated that after his term as Chair ends in mid-May, he will remain on the Board until the investigation is clearly concluded, a situation not seen since 1948. This means Warsh will inherit a potentially more divided Fed, making it difficult to quickly alter the internal hawk-dove balance by appointing a new Governor to fill Powell's vacancy.
Future rate cut path: Theoretically, two cuts are warranted, but practicality depends on oil prices and Trump.
Theoretically, from a fundamental perspective, the Fed still should and needs to cut rates approximately twice; this is one reason we are more optimistic about cuts than the market. From a neutral interest rate perspective, the current U.S. real rate remains about 50 basis points above the natural rate, suggesting room for two 25-bp cuts. Furthermore, recent rising oil prices have pushed up Treasury yields, causing a renewed decline in underlying growth data like existing home sales and industrial production, which still require the support of rate cuts.
As long as oil prices do not remain above $100 until year-end, high base effects should help pull inflation down, providing the Fed room to cut. The lower bound of the Fed's rate is slightly above the March CPI reading. Estimates suggest that if oil prices gradually fall to around $80 in the third and fourth quarters, U.S. CPI could drop to around 2.7%-2.8% due to base effects. Conversely, for the Fed to be unable to cut, inflation would need to rise to 3.5% and stay above that level for the rest of the year, implying oil prices averaging above $100 until December. This scenario depends on the Iran situation persisting into the second half of the year, which, considering Trump's midterm election pressures and record-low approval ratings, may be difficult to sustain.
In practice, however, cooperation from oil prices and Trump is needed. The stalemate with Iran keeping oil prices high, and Powell's decision to stay on due to the investigation, leading to Fed fragmentation, are not issues Warsh can solve alone after taking over in June. The key lies with Trump. If a swift compromise is reached and the investigation into Powell is concluded definitively, the prospect for rate cuts would gradually open up.
New Chair Warsh: Taking over in June, supports cuts constrained by oil prices, QT fears may be exaggerated.
New Fed Chair Kevin Warsh is highly likely to take over before the June FOMC meeting. Having completed his Senate hearing and secured committee approval, he only needs full Senate confirmation and the presidential appointment. With the investigation into Powell subsided and Republicans controlling the Senate, Warsh's appointment faces almost no obstacles. Prediction markets currently assign a 97% probability of Warsh formally becoming Chair before June, meaning he will likely主导 the rate decision at the June 17 FOMC meeting.
Warsh supports rate cuts, but is constrained by oil prices and Trump. Warsh's core stance has centered on rate cuts and balance sheet reduction. While he did not directly call for cuts during his hearing, he proposed a new inflation framework, including considering AI's impact and using trimmed-mean inflation metrics. According to Dallas Fed calculations, the 12-month trimmed mean PCE has declined, which could provide more room for cuts if referenced.
Regarding balance sheet reduction, even if pursued, it would require looser financial regulations first and remains constrained by financial liquidity in the short term. After the New York Fed slowed its balance sheet expansion, reserves have declined, hovering near the threshold of "ample reserves." Furthermore, the once-abundant ONRRP is nearly depleted, unable to effectively offset QT. In the short term, Warsh would face constraints from financial liquidity, market volatility, and Trump's midterm election pressures if he pushes for QT, requiring prior regulatory relaxation for banks to hold more Treasuries. Therefore, near-term market fears about QT may be exaggerated.
Asset implications: Equities largely price in easing; gold, U.S. Treasuries, and Hang Seng Tech price in less. Rotation if easing occurs, defense if tightening.
Based on current market pricing for rate cuts over the next year, the hierarchy is: Fed Dot Plot > S&P 500 > Nasdaq > Copper > Rate Futures > Dow Jones > Gold ≈ U.S. Treasuries. This indicates that equity assets like U.S. stocks have priced in more easing, while U.S. Treasuries and gold are the most hawkish.
Markets have recently become desensitized to the Iran situation, with equity indices like the Nasdaq hitting new highs. This is because the situation, while stalled, has not systematically escalated, and sectors like tech are less immediately impacted by oil prices and have strong industry narratives. Consequently, U.S. and A-shares are experiencing extreme structural rallies driven by AI hardware, which also explains the lag in Hong Kong stocks. Currently, markets have largely priced out the tail risk of extreme escalation, with risk premiums for major indices mostly recovered. Profitability differences are key to explaining divergences across markets and sectors. If the stalemate persists, the impact of high oil prices on profits for mid/downstream industries and vulnerable regions will gradually emerge, which is not yet fully priced in. In contrast, if oil prices don't stay high until year-end, there is room for repricing of risk-free rates and rate cut expectations, especially for assets like U.S. Treasuries and gold that currently price in fewer cuts.
The Iran situation is a game of chicken; whichever side faces higher costs and greater pain is more likely to compromise. Iran's costs have increased since the U.S. blockade began, creating internal dissent. The U.S. short-term cost is low, but medium-term costs are high, with Trump's approval rating falling. Therefore, short-term volatility is expected, but a full-scale escalation mid-term serves neither side's interests. In such a scenario, systemic volatility risk is controlled, but real cost pressures exist for mid/downstream industries and vulnerable areas.
Key upcoming focuses include: progress in U.S.-Iran negotiations, Trump's visit to China, and developments regarding Warsh's succession. If these events progress positively, leading to lower oil prices, improved external demand expectations, and returning rate cut expectations, investors could consider sectors sensitive to U.S. Treasury yields and broad external demand themes, alongside rotation within tech. If the situation deteriorates, raising global demand risks, controlling position sizes and focusing on defensive sectors with clear earnings visibility would be prudent.
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