The Federal Reserve is highly likely to announce a 25 basis point (BP) rate cut at its meeting this Thursday, continuing its momentum of implementing a loose monetary policy. However, with the steady growth of the U.S. economy and potential policy changes under the Trump administration, the market’s expectations for the Fed’s future rate cuts have become more uncertain. The path of future rate cuts by the Fed is uncertain and may slow down gradually.
Barclays and other analysis institutions generally believe that although this week's rate cut by the Fed is almost certain, the rationale for further cuts may become less compelling amid continued economic growth. Nick Timiraos, a reporter from The Wall Street Journal, points out that investors widely anticipate the Fed to cut rates in December, but if the economy continues to grow robustly, the frequency and magnitude of rate cuts could decline. Eric Robertsen, Standard Chartered's global chief strategist, notes that market expectations for the rate cut magnitude by 2025 have been revised down from the initial 130 basis points to less than 50 basis points, indicating that the market has realized the potential for the Fed’s rate cut momentum to slow down.
This change is also reflected within the Fed itself. Cleveland Fed President Beth Hammack states that the Fed is approaching the correct timing to slow the rate cut pace. Fed officials believe that while the economy is still growing, nearing the neutral interest rate level makes further substantial rate cuts more challenging. The Fed’s estimate for the neutral rate range is usually between 2.5% and 4%, with the current federal funds rate close to 4.6%. If inflation continues to fall and the labor market shows no weakness, the motivation for rate cuts may weaken.
From the perspective of U.S. economic data, recent inflation and employment figures have been strong. Inflation in November rose slightly year-over-year to 2.7%, exceeding the Fed’s 2% target, and non-farm payrolls in November increased by 227,000, surpassing expectations. Such data has tempered market expectations for future rate cuts, and even some Fed officials have expressed concerns about the potential for continued cuts to trigger asset bubbles.
Additionally, policy changes from the Trump administration could significantly impact the Fed’s monetary policy. Kristina Hooper, chief market strategist at Invesco, highlights that four key policies of the Trump administration—deregulation, tax cuts, tariffs, and immigration restrictions—could have profound impacts on the economy and inflation. In particular, the tax cut policy might stimulate economic growth and create inflationary pressure, influencing Fed decisions.
In contrast, China's monetary policy outlook is relatively clear. The People's Bank of China is expected to continue rate cuts in the future, especially with the December economic work conference emphasizing “implementing a moderately loose monetary policy”. The market anticipates continued rate cuts by the People's Bank of China in 2024, with the 1-year and 5-year Loan Prime Rate (LPR) likely to decrease by 30 and 60 basis points, respectively. Analysts at Nomura forecast that the central bank will cut rates by 15 basis points in the first and second quarters of 2024.
With the divergence in monetary policy paths between China and the U.S., the interest rate differential between the two countries is rapidly widening. As of December 17th, the yield on China's 10-year government bonds has fallen sharply to 1.72%, down nearly 50 basis points from November 29th. Meanwhile, the yield on U.S. 10-year government bonds continues to rise, reported at 4.418%, widening the China-U.S. differential to almost 270 basis points, the largest since 2002. This change has drawn attention to the potential impact of economic and monetary policy differences between China and the U.S. on global capital flows and exchange rate fluctuations.
In summary, although the Fed is expected to continue rate cuts this week, the pace of future cuts may slow, and market expectations for cuts by 2025 have already been adjusted. Meanwhile, the further widening of the China-U.S. interest rate differential could have significant effects on global capital flows, requiring investors to closely monitor the potential impacts of Fed policy and Trump administration policies on the economy and inflation.
