Federal Reserve's Major Shift in Decision: Increased Expectations for Rate Cut in September, Market Responds Enthusiastically

Authors: Zhao Yuhe, Li Dan, Du Yu, Fang Jiayao, Wall Street Watch

The Federal Reserve remained on hold at the July FOMC meeting, deciding to keep the federal funds rate target range at 5.25% to 5.5% and continuing to reduce its securities holdings. Fed Chair Powell stated that the feeling of being closer to a rate cut is reasonable, and the FOMC may discuss the issue of rate cuts in September.

The Fed's decision and Powell's press conference both suggest a possible rate cut in September. Analysis from the "New Fed Communicator" indicates that the Fed's statement removed the wording of "heightened concern" about inflation risks that had been present for the past two years, which is a significant shift, indicating that inflation may no longer be an obstacle to rate cuts, especially as the labor market continues to cool.

The S&P and Nasdaq saw their largest gains in five months, with the S&P 500 index rising over 2% during the day and the Nasdaq climbing over 3%, marking the best single-day performance since February.

A Major Shift in the Fed's Decision

On Wednesday, July 31, at Eastern Time, the Federal Reserve announced after the FOMC meeting that the target range for the federal funds rate remains at 5.25% to 5.50%. The FOMC voting members of the Fed have unanimously supported the rate decision for the 17th consecutive meeting.

Thus, in this tightening cycle that began in March 2022, the Fed has not raised rates for eight consecutive meetings. Since the rate hike in July last year, the Fed has kept the policy rate unchanged at its highest level in over twenty years. As the market expected, the Fed maintained high rates but simultaneously signaled a possible rate cut in September: the Fed further confirmed progress in reducing inflation, and besides inflation, it began to emphasize the need to avoid risks to employment.

The statement changed to describe inflation as "somewhat" elevated, indicating "some" further progress in reducing inflation, that employment growth has "somewhat slowed," and that the unemployment rate remains low but has "increased somewhat."

The statement no longer states that it "remains highly concerned about inflation risks," but instead refers to the risks facing the dual mandate of employment and inflation.

The statement continues to emphasize that it is not appropriate to cut rates until there is more confidence in reducing inflation, and that the risks to employment and inflation remain more balanced. The "New Fed Communicator" stated that the Fed has cleared the way for a rate cut in September, treating employment and inflation targets more equally for the first time in two years, which means that inflation may no longer be an obstacle to rate cuts.

After the decision was announced, Timiraos wrote an article proclaiming that a rate cut in September is imminent, titled "The Fed Clears the Way for a Rate Cut in September." The article pointed out that although the rates remain unchanged, Fed officials made a significant shift this time, emphasizing a more equal focus on the dual goals of employment and inflation, suggesting they are getting closer to a rate cut.

George Goncalves, head of U.S. macro strategy at Mitsubishi UFJ Financial Group, commented that the Fed's statement shows that they have modified enough elements and carefully considered how to express a shift towards easing.

Some analyses also noted that the dovishness of the decision was slightly less than expected and did not express greater confidence in reducing inflation.

Powell Hints at a Rate Cut in September

Fed Chair Powell stated that the feeling of being closer to a rate cut is reasonable, and the FOMC may discuss the issue of rate cuts in September.

He said that the Fed will continue to make decisions at each meeting, as reducing policy restrictions too early or too aggressively could reverse the progress made on inflation. At the same time, delaying or reducing policy restrictions too little could excessively weaken economic activity and employment.

Powell stated that the FOMC will carefully assess the latest data, the evolving outlook, and the balance of risks.

If the economy remains robust and inflation persists, the Fed can maintain the current federal funds rate target range at the appropriate time. If the labor market unexpectedly weakens or inflation declines faster than expected, the Fed is also prepared to respond. The Fed's policy is ready to address the risks and uncertainties faced in pursuing its dual mandate. In the subsequent Q&A session, Powell stated that the market's feeling of the FOMC being closer to a rate cut is reasonable. He said that a rate cut could be an option at the September FOMC monetary policy meeting, and the FOMC may choose to cut rates as early as September. He revealed that the general view of the FOMC is that they are currently approaching the appropriate time for a rate cut, but have not yet fully reached that point. Key points from Powell's press conference are summarized as follows:

• Rate cut outlook: The market's feeling of the FOMC being closer to a rate cut is reasonable, and a rate cut may be chosen as early as September, weighing the risks of acting too early against waiting too long. Therefore, "zero to a few rate cuts this year" are all conceivable scenarios.
• Inflation: The current decline in inflation is better than in 2023 and is more widespread. Due to good data, our confidence in inflation continuing to fall towards the target of 2% is increasing.
• Employment: The labor market has returned to pre-pandemic levels, strong but not overheating. The downside risks facing the labor market are actually low, with particular attention to private sector employment demand.
• Elections: There is absolutely no belief that a potential Fed rate cut in September is related to political factors; the Fed has never used (policy) tools to oppose a party or election outcome, nor will it decide FOMC policy based on the results of the U.S. elections.
• Digital currency: The FOMC did not discuss the issue of whether to issue a Fed digital currency at all. Progress on central bank digital currency (CBDC) has not been significant, and there are no plans to discuss this issue with Congress.

Market Surge: S&P and Nasdaq Post Largest Gains in Five Months, Nvidia Soars Nearly 13%, Oil Prices Jump 4%

The Fed's decision and Powell's press conference both suggest a possible rate cut in September, leading U.S. stocks, bonds, crude oil, gold, and the yen to rise, with market expectations for rate cuts heating up. The CME FedWatch Tool shows that traders expect the Fed to cut rates three times before the end of the year, totaling a 70 basis point cut this year, up from a previous expectation of a 64 basis point cut. Calls for rate cuts are rising, with "New Bond King" Gundlach and Senate Democrat "antitrust fighter" Warren both urging for a rate cut now.**

Rate cut expectations initially fell, then surged U.S. stock indices continued to rise overall, refreshing daily highs during Powell's press conference around 3 AM Beijing time, with the tech-heavy Nasdaq closing up nearly 3.2% and leading the major indices; the S&P 500 index rose over 2.1% at its peak; the Dow, closely related to the economic cycle, rose over 1.1% at its peak; and the Russell small-cap index rose over 2.5% at its peak.

Chip stocks rebounded sharply, with the Nasdaq rising over 3% during the day, the S&P briefly rising over 2%, Nvidia soaring nearly 13%, the chip index rising 7%, and the small-cap index cumulatively rising 10%, marking the best performance of the year.

With Powell hinting at a possible rate cut as early as September, U.S. Treasury yields plummeted, with the two-year yield falling 9 basis points and a cumulative drop of over 48 basis points in July. At the close, the two-year U.S. Treasury yield, which is more sensitive to monetary policy, fell 8.87 basis points to 4.2698%. It rose to a daily high of 4.3894% when the FOMC rate decision statement was released at 2:00 AM Beijing time, then declined after Powell hinted at a possible rate cut in September, dropping to a daily low of 4.2554% at 3:59 AM (just one minute before the U.S. stock market closed), with a cumulative drop of 48.36 basis points in July. The yield on the benchmark 10-year U.S. Treasury fell 10 basis points, refreshing its daily low to 4.0392%, with a cumulative decline of 35.31 basis points in July.