CICC has released a research report stating that the Federal Reserve has no need or basis for consecutive and substantial rate hikes, for the following reasons: First, traditional demand does not support large rate increases. Second, inflation will fall rapidly first due to the high base effect. CICC roughly estimates that US CPI will return to 2% by May 2027, significantly below the current 3.7%. Third, AI's own investment returns and financing pressures have also wavered, with the first half of next year being a key verification point. The current lack of new narratives and catalysts to open up the "ceiling" of AI application scenarios is the key reason why weak links such as CoreWeave's credit risk continue to climb, mirroring the situation at the end of last year when AI similarly lacked progress and the market worried about private equity credit risk.
At the October FOMC meeting concluded in the early hours of this morning Beijing time, the Federal Reserve held rates steady as expected, maintaining the benchmark rate at 3.75-4%. The incremental information released at this meeting was very limited. Fed Chair Warsh remained tight-lipped and once again stated he does not like forward guidance. Additionally, the decision not to hike at this meeting was entirely within market expectations, as market changes were also very limited. After the meeting, US Treasury yields were basically unchanged, with the 10-year yield edging up slightly above 5%, US stocks also maintained range-bound trading, and the CME-implied probability of a December rate hike remained around 85%.
Although after the previous September rate hike, rate hike expectations fluctuated several times, during which September CPI and PPI exceeding expectations also triggered market concerns, the overall policy direction also aligned with CICC's previous judgment that the September rate hike was necessary to maintain credibility (this was basically achieved, with the term premium returning to the 60bp level before concerns escalated in July), but consecutive and substantial rate hikes are unnecessary ("Is One Fed Rate Hike Enough?"). After the September rate hike, the market environment has quietly changed: rising financing costs are already squeezing traditional demand such as real estate, and weak links in AI such as NeoCloud representative CoreWeave's CDS and junk bond spreads are also rising rapidly, all reflecting tighter financial conditions. The outlook for AI demand and the sustainability of capital expenditure has also been clouded. US Treasury yields seem to be topping out, oil prices remain elevated, so is a December Fed rate hike a foregone conclusion? How many more times will the Fed hike? Chart: October rate hike expectations rose above 70% by end-September, but had fallen to less than 10% before the meeting. Source: Bloomberg, CICC Research Department.
Core Information from the October FOMC
Pause in rate hikes, subsequent decisions data-dependent; strong economy but tightening financial conditions; reduce the number of meetings going forward. The incremental information provided at this meeting was very limited, mainly conveying the following signals: 1) Maintaining the benchmark rate at 3.75%-4%, in line with market expectations; 2) The economy remains strong; 3) Financial conditions are beginning to tighten, reflected in some credit spreads, especially high-yield bonds; 4) Future decisions depend on data, with 2 more nonfarm payroll reports and 1 inflation report before the December FOMC. The September meeting minutes showed that participants generally emphasized inflation remains elevated while labor market risks have diminished, so most officials indicated that one more rate hike may still be needed by year-end; 5) Warsh once again emphasized he does not like forward guidance, and the number of meetings will be gradually reduced in 2027 and 2028.
Future Policy Path: Consecutive and Substantial Rate Hikes Are Also Unnecessary; First Half of Next Year Is the Key Verification Point; Market Expectations Are Basically Unreliable
The Fed's pause in rate hikes this time was already within market expectations and consistent with CICC's previous judgment. Before the September rate hike was implemented, CICC noted that the Fed needed to hike to rebuild market trust, but also emphasized that US fundamentals do not support consecutive and substantial rate hikes ("What Happens If Rates Rise?"). Since the purpose of rebuilding trust has been basically achieved for now (the 10-year US Treasury term premium has fallen back to the market expectation level before Warsh's July FOMC remarks), nonfarm payrolls are weakening, AI concerns are increasing, financial conditions are tightening in some areas, and supply constraints are not yet significantly strained, so why shouldn't the Fed observe for a while, especially with midterm elections on the horizon.
Looking ahead, CICC still believes that the Fed has no need or basis for consecutive and substantial rate hikes, for the following reasons: First, traditional demand does not support large rate increases. The US economy remains in a K-shaped divergence of "strong tech but weak traditional demand," and current interest rate levels have already begun to significantly squeeze traditional demand. Taking real estate as an example, the 30-year mortgage rate has risen to a multi-year high of 7.5%, significantly higher than the 6% rental yield, and existing home sales have weakened again since May; short-term small business loan rates have also risen to 8.2%. Chart: The US economy remains in a K-shaped divergence of "strong tech but weak traditional demand." Source: Haver, CICC Research Department. Chart: Existing home sales continue to weaken under the pressure of rising US mortgage rates. Source: Haver, CICC Research Department. Chart: Both US 30-year mortgage rates and short-term small business loan rates are rising rapidly. Source: Bloomberg, CICC Research Department.
However, AI's strength has offset and masked the pressure on traditional demand in aggregate terms. But as AI begins to draw resources from the broader economy, its crowding out of traditional demand in both physical and financial factor resources will become increasingly evident. Previously, the positive externalities brought by AI demand supported US economic growth and provided the "confidence" for Fed rate hikes. But as AI begins to need more external funding to support investment, the crowding-out effect is also unavoidable, potentially gradually turning from a "friend" of traditional demand to an "enemy" ("AI: From Friend to Foe of Traditional Demand?"). AI's massive bond issuance and the Fed's need to hike rates are typical examples. Once AI's investment returns and positive externalities weaken, the combined effect cannot be sustained, and the Fed will find it difficult to continue hiking. Chart: In Q2, US real GDP grew at a 2.2% annualized rate, with AI-related demand contributing 28% of growth. Source: Haver, CICC Research Department.
Second, inflation will fall rapidly first due to the high base effect. From the first half of this year until May, the high base caused by the Iran situation will cause overall US inflation to fall rapidly. Based on an assumption of maintaining current oil prices (around $95/barrel), CICC roughly estimates that US CPI will return to 2% by May 2027, significantly below the current 3.7%. Chart: CICC estimates that the high base will push CPI year-over-year down to around 2% in the first half of 2027. Source: Haver, CICC Research Department.
Geopolitics and oil prices are indeed short-term disturbances that affect the path; but over a longer horizon, they do not affect the trend. If short-term geopolitical tensions escalate again and push oil prices higher, it would indeed increase the risk of CPI exceeding expectations and rate hike pressure, which is the biggest variable in the short-term path. But over a longer horizon, geopolitical conflicts do not necessarily lead to sustained contraction of crude oil supply, because current high premiums mean that even if the Strait of Hormuz is not open, various alternative transportation routes (such as pipelines, ship-to-ship transfers, etc.) have basically restored Gulf exports excluding Iran to pre-conflict levels. The same was true during the 2022 Russia-Ukraine conflict—although the geopolitical situation has not fully eased, Russia's crude oil supply gradually recovered to pre-conflict levels, and oil prices gradually fell. Therefore, there is path disturbance in the short term, but it may not affect the trend in the medium term. Chart: According to Kpler data, crude oil exports from Gulf countries excluding Iran have also recovered to pre-conflict levels. Source: Kpler, CICC Research Department. Chart: The gradual release of medium-to-long-term crude oil supply will push oil prices lower. Source: Haver, CICC Research Department.
Third, AI's own investment returns and financing pressures have also wavered, with the first half of next year being the key verification point. The current lack of new narratives and catalysts to open up the "ceiling" of AI application scenarios is the key reason why weak links such as CoreWeave's credit risk continue to climb, mirroring the situation at the end of last year when AI similarly lacked progress and the market worried about private equity credit risk. The first half of next year is a key juncture, similar to how Anthropic's results significantly exceeded expectations in Q1 this year, proving to the market that the coding business closed loop works. Otherwise, if progress is delayed, market patience will be exhausted, and the outlook for 2028 capital expenditure and returns will further dim. As the primary driver of growth and earnings currently, if one does not have strong confidence in AI, how can one expect the Fed to continue hiking?
In summary, traditional demand beginning to come under pressure plus rapid inflation decline in the first half both seem to not support consecutive and substantial Fed rate hikes. Moreover, if AI demand slows more than expected, the Fed may even need to cut rates, with the first half of next year being the key verification point for AI and the policy path. The upside risks to CICC's view are persistently higher-than-expected oil prices and significantly better-than-expected AI progress. As for market expectations, historical experience shows they are almost always unreliable. Chart: Historical experience shows that the rate path implied by interest rate futures deviates from the final actual path. Source: Bloomberg, CICC Research Department.
How High a Rate Can the US Tolerate? 6% May Be the Watershed
On one side is AI's strength, on the other is traditional demand gradually coming under pressure and being crowded out. When might AI's positive externalities no longer offset the weakness of traditional demand? CICC estimates in "AI: From Friend to Foe of Traditional Demand?" that this watershed may be around a 6% 10-year US Treasury yield (AI can tolerate 7% or even higher, while traditional demand can tolerate around 4-4.5%). This also explains why the recent rise in US Treasury yields has not yet fully hurt overall growth, but erosion of local weak links has already begun to appear. If this inflection point is exceeded, AI's positive externalities cannot continue to offset negative externalities, causing overall growth to come under pressure, and the Fed may even need to start cutting rates.
How Will the Market Trade? A Brief Rate Hike Still Fits the "Sell the News" Pattern
The recent topping and pullback in US Treasury yields basically fits the pattern of rate hikes being priced in upon implementation. CICC noted in its September report "Is One Fed Rate Hike Enough?" that a rate hike being implemented is not bad for the market; rather, it may mean "bad news exhausted." A typical case is the 1997 "preventive rate hike," after which US Treasury yields quickly peaked and fell; conversely, the "preventive rate cuts" of 2019, 2024, and 2025 also played out a similar "script," with US Treasury yields gradually rising at or shortly after the rate cut was implemented ("What Happens If Rates Rise?"). Comparing to this time, although October inflation data caused rate hike expectations to "rebound" and US Treasury yields to rise again, if a brief rate hike is the base case, it still fits this pattern. Based on the dot plot's one more hike, a 4-4.25% benchmark rate plus a 70-90bp term premium corresponds exactly to a 10-year US Treasury yield of around 5.3%. Therefore, if CICC's judgment on the Fed's future rate hike path above is accurate, the tightest moment of financial conditions is also gradually approaching. Chart: A 4-4.25% rate expectation plus a 70-90bp term premium corresponds to a US Treasury yield top of around 5.3%. Source: Bloomberg, CICC Research Department.
US stocks more reflect AI narratives and emotional disturbances from midterm elections. CICC further raised its S&P 500 target to 7,800-8,000 in its June mid-year outlook, and the market has been oscillating indecisively after reaching this level. In addition to liquidity disturbances from rising rates, the recent rise in AI financing risks and slowing revenue realization have suppressed the overall AI narrative, so the market has also "narrowed" to cloud vendors with reasonable valuations and expectations that do not fully depend on future high-growth assumptions. As US corporate earnings remain solid while valuations have actually contracted, CICC remains not pessimistic on the US stock market outlook. Chart: CICC's AI Stress Index has also continued to rise since end-September. Source: Bloomberg, FactSet, CICC Research Department.
The dollar strengthened amid falling US Treasury yields and easing rate hike expectations, partly reflecting Europe's weaker "contrast" and capital flowing back again. Although US Treasury yields have begun to fall, the dollar has not weakened in tandem, mainly because Europe faces greater uncertainties in politics and fiscal policy, so some capital has flowed back, with the only question being whether it chooses US Treasuries or US stocks. Chart: The dollar is range-bound in the base case, with short-term Fed rate hikes to rebuild trust still providing support for the dollar. Source: Bloomberg, CICC Research Department.
Gold currently resembles more of a "bullish option," with three layers of meaning: First, a certain "option premium" must be paid, i.e., time cost; Second, downside pressure is controllable, with the biggest risk being consecutive and substantial rate hikes; Third, option realization requires "exercise conditions," i.e., narratives, such as at the end of last year when market concerns about AI investment returns, US policy stability, and Fed credibility jointly catalyzed a major gold rally. Chart: Gold's greater upside comes from grand narratives. Source: Polymarket, CICC Research Department.
Looking at the rate hike expectations for the next year priced into various assets: interest rate futures (3 times) > gold (2.4 times) > copper (1.9 times) > Dow Jones (1.7 times) = US Treasuries (1.7 times) > S&P 500 (1.1 times) > dot plot (1 time) > Nasdaq (0.4 times). Chart: From the rate hike expectations for the next year priced into various assets: interest rate futures > gold > copper > Dow Jones = US Treasuries > S&P 500 > dot plot > Nasdaq. Source: Bloomberg, CICC Research Department.
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