Powell's speech did not exceed the script expected by the market.
Whether it was a 75 basis point interest rate hike or a speech after the meeting, it did not bring too many surprises to the market, let alone shock. Powell continued his steady and conservative style in the past and put the landing of this interest rate hike firmly within the expected red line.
As early as Tuesday, in our forecast of the Fed's interest rate hike, we mentioned that the current market expectation of the Fed's interest rate hike path is: 75 BPS in September, 75 BPS in November and 50 BPS in December. The Eurodollar interest rate market has already completed the pricing in of another 200 basis points this year.
Look at last night's interest rate statement and the chairman's speech after the meeting, and the results are not bad at all.
1. Clearly gave the path of raising interest rates this year
At the press conference, Powell predicted that another 100 to 125 basis points will be added this year, which is completely consistent with the total number of interest rate hikes we expected this year.
and greatly reduced the uncertainty of interest rates, which is of course good news for the market that has almost fully priced 200 basis points.
2. Re-emphasize that the main task of the Federal Reserve is to reduce inflation.
But admit that getting rid of inflation may lead to recession
Powell admits there is no painless way out of inflation and that a soft landing is very challenging.
This should be the third time he has spoken publicly about the challenges of a soft landing, highlighting the fragility of the economy while raising interest rates sharply? What does this mean?
Quite simply, the Fed is hoping that the market can start pricing the recession, so that it will be much easier to reduce inflation.
Let's look at the market·s performance in the interest rate market:
Eurodollar interest rate futures have hardly changed. The only difference is that with the expected interest rate hike, the valuation of the end point of this round of interest rate hike has reached 4.6%, which is about 10 basis points higher than the previous 4.5%.
Pre-meeting price structure:
Post-meeting price structure:
Will this 10 basis point increase change the Fed's interest rate hike path for the rest of this year? Will it trigger a sharp drop in US stocks? I'm afraid it's difficult.
From the Dot Plot, compared with the previous June, the end point of interest rate increase in it has been greatly increased, from less than 4% to more than 4.5%, which is consistent with the current pricing of Eurodollar interest rate futures. The market has already digested this change, which of course will not bring any pressure to the market.
However, there is a very subtle change. In the swap market and the US federal interest rate futures market, the pricing of interest rate trends next year is not as radical as Dot Plot, but actually pricing interest rate cuts next year!
This is interesting, because a large number of traders still think that the Fed is bluffing and doesn't want to bet the end of interest rates so high.
Why is the market pricing the future interest rate trend so gently?
Can last night's drop of less than two percentage points be compared with the drop of more than four percentage points on September 13th? Then why did the drop on the night of interest rate increase not have the pain from the plunge on the night of CPIQuick?
The answer is very simple. The last CPI announcement night was at the beginning of the pricing in of US stocks for future sharp interest rate hikes. In addition, Ukraine and Russia war had an obvious escalation tendency.
Last night, Russia just started the large-scale recruitment and expansion of weapons for the first time since World War II, and the sharp interest rate hike by the Federal Reserve and the overall interest rate hike path this year all landed.
So what else can make US stocks fall lower after the bad news is exhausted?
In the swap and interest rate futures markets, there are two possibilities for interest rate cuts starting in 2023,
One is that the futures forward market has not finished pricing in the higher interest rate end next year.
Another possibility is that traders believe that next year, before interest rates reach 4.6%, the United States will fall into recession. This is probably what Powell hoped for. A mild recession can bring down prices and slow down interest rate increases to curb the decline in the United States, which is already a good result for the current environment.
Therefore, the Federal Reserve drastically lowered its forecast of future GDP growth this time.
They believe the median growth forecast for this year is just 0.2 pc, down from the 1.7 pc forecast in June.
Unemployment forecasts have been raised, with the median for 2023 and 2024 now at 4.4 pc. The long-term unemployment rate remained unchanged at 4%.
The overall and core PCE forecasts for this year and next year are both raised. The Fed doesn't think inflation will return to its 2% target until 2025.
After each interest rate hike,
Interest is unbearable
That is the real pressure on the Fed to raise rates, which will add another $2.1 trillion to the national debt over the next decade, according to the CFRB, the agency responsible for the federal government's budget. Issuing bonds to repay interest may be the only choice for the government. But who will buy the newly issued bonds during QT? It's still an unsolvable problem
At present, the debt of the US federal government is 30.9 trillion US dollars. As of fiscal year 2022, the U.S. Treasury Department has allocated $471 billion, which is only used to pay the government's interest. At this time in fiscal 2021, the Treasury's interest payout was $356 billion. This means a 30% year-on-year increase.
Interest payments are expected to triple from nearly $400 billion in fiscal 2022 to $1.2 trillion in 2032, according to the CFRB. As a direct result, the default rate and the selling pressure of US debt have increased
Every mid-term election is a reckoning, and Powell chose the latter between the soaring prices and fiscal deficits.
We believe that the rise in interest rates will probably not stop next year, regardless of whether the recession comes early or not. To curb the current inflation rate of over 8%, it may be possible to raise the base rate to over 6%. And the whole cycle of raising interest rates will probably exceed one year.
Therefore, US stocks will fluctuate greatly for a long time. As now, the market trend of buying expectations and selling facts will be repeated in the future.
Will there be a short covering in US stocks?
So how do you choose?
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