The Federal Reserve’s decision-making framework has experienced half a century of evolution and upgrading, and by 2020 it has basically formed a relatively mature model for responding to economic cycle changes and shocks. The collapse of the Bretton Woods system in the 1970s and the long-term global “stagflation” caused by two oil crises made the Federal Reserve realize that it must implement extremely severe monetary tightening in a high-inflation environment. In the 1980s, the Federal Reserve strengthened its understanding of the importance of “preemptive tightening” to curb signs of rising inflation. The Plaza Accord had little effect on the U.S. balance of payments, and the Federal Reserve began to initially perceive the special logic of the U.S. dollar’s global seigniorage status. In the 1990s, the Federal Reserve officially abandoned the international balance of payments goal in the original “three-yuan long-term goal” and changed quantity-type regulation to price-type regulation, adapting to the high-growth, low-inflation environment brought about by the wave of technological progress. The basic stance of monetary policy From tight to loose. Entering the new century, persistently low inflation caused the Federal Reserve to condone the “irrational exuberance” of the real estate market through excessive easing. After the subprime mortgage crisis-global financial crisis broke out in 2007-2008, the Federal Reserve had to take measures including zero interest rates. Non-traditional monetary policies, including direct purchases of MBS and ultra-large-scale purchases of long-term Treasury bonds (QE), successfully prevented the collapse of the financial system, but it also took six years of hard work to rebuild the monetary and credit transmission mechanism.
After the outbreak of the global COVID-19 pandemic, the Federal Reserve’s monetary policy can be roughly divided into four stages. It is currently in the late third stage. The degree of easing in the fourth stage is likely to be lower than market expectations. The first stage is the non-traditional quantitative easing stage adopted after the outbreak of the epidemic in 2020; the second stage is the stage where the upward trend of inflation appears in 2021 and the Federal Reserve delays contraction; the third stage is the interest rate hike and contraction stage starting in 2022. The table shows a stage in which the wage inflation spiral has intensified; the fourth stage is an easing stage after seeing a stable trend of gradual downward inflation in the future.
The third and fourth stages are largely a correction of the excessive easing operations in the first and second stages. At the same time, due to the relatively strong U.S. economy and the general recession in non-U.S. developed economies, the Fed is currently at the end of the tightening stage and in the second half of 2024. In the early stage of a possible new round of interest rate cuts, the U.S. dollar index is likely to remain at a high level for a longer period of time, causing various non-U.S. economies, including China, to face contractionary spillover effects for a long time, which will have a negative impact on China in the future. The mix of economic policies poses new challenges.
Drift in the Fed’s decision-making framework
The current huge differences in the market on the future direction of the Federal Reserve’s monetary policy mainly stem from different expectations on the sustainability of the current high economic growth and inflation levels in the United States. The complexity of the current U.S. economic structure and high inflation is largely due to This was caused by the nature of the Federal Reserve’s monetary policy operations in the early stages of the COVID-19 pandemic.
The Federal Reserve quickly decided to implement non-traditional quantitative easing in March 2020, which included three aspects: First, it quickly lowered interest rates to the zero lower limit; second, it restarted a new round of QE plan to purchase Treasury bonds and MBS and said that the purchase scale was “unset.” “Overall cap”, even adding commercial mortgage-backed securities (CMBS) to the scope of MBS’s bond purchases, and going further than the QE from 2009 to 2014 in the central bank’s direct purchase of bonds with credit default risks; three , all the series of loan and repurchase liquidity support tools launched in 2008 have been restored to use, and some new liquidity injection tools including PPPLF, PMCCF, SMCCF, etc. have been launched, which has greatly enhanced the breadth, depth and speed of this round of quantitative easing. All far exceeded the previous round.
A new round of quantitative easing (QE) measures that are more radical than those implemented six years after the 2008 global financial crisis, while effectively stabilizing confidence in the U.S. financial system and various economic sectors, also show obvious characteristics of excessive aggregate volume and structural imbalance. , highlighting the lag and blindness of the monetary policy decision-making model proposed by Powell after taking office, which is based on current economic performance (rather than predictions of the future).
A year and a half before the outbreak, Powell said in a public speech at the Jackson Hole annual meeting that monetary decisions should not rely on estimates of potential output, implying that compared with the huge ex post inaccuracies of economic forecasts, the current economic performance May contain more information useful for Fed decision-making. As a result, the Federal Reserve has gradually given up the “anchor” of the potential output path and instead adopted a synchronous or even lagging “comprehensive analysis” method to make real-time decisions. This has made the Fed’s monetary policy operations more subjective, and improper policies have led to economic downturns. The risk of inflation deviating from its long-term center has increased significantly.
Affected by this “decision-making framework drift”, at the beginning of the epidemic’s impact on the U.S. economy, the Federal Reserve actually gave up measuring the short-term output gap and directly adopted an unlimited QE policy. In hindsight, the total liquidity injection was obviously excessive.
In this round of QE operations, while the real estate market has not been exposed to systemic risks and the financial system has not suffered potential capital losses and liquidity depletion risks, it has aggressively implemented an MBS purchase plan that exceeds the previous round of QE, and liquidity has flooded to a certain extent. The rise has increased the degree of bubbles in the U.S. real estate market and is not conducive to the effective expansion of credit demand in the real economy.
This kind of operation sowed the seeds of partial turmoil in the U.S. banking industry in March 2023, and to a large extent has also become the reason why the current global market has become more divergent about the U.S. real estate market and economic prospects. Excessively rapid purchases of Treasury bonds and MBS caused U.S. Treasury bonds and long-term mortgage interest rates to fall sharply in a short period of time, hitting new lows in recent decades. On the one hand, the sharp decline in mortgage loan interest rates directly pushed up the periodic bubble in the real estate market; on the other hand, The sharp decline in long-term government bond interest rates has caused the valuations of financial markets such as stocks and bonds to rise rapidly, and the financial markets have also rapidly become bubbles, far exceeding the peak of the previous round of QE.
Wage inflation spiral
The United States is still in the stage of gradually digesting excess savings caused by excessive subsidies in the early stage. In addition, wage growth remains high, and residents’ income and consumer purchasing power remain strong. Compared with sustained tax cuts, the increase in residents’ income brought about by periodic fiscal subsidies will be converted into excess savings in a larger proportion to be gradually digested in the future, but the proportion used for the increase in current consumption is actually not high.
Our calculation results show that the excess savings of the U.S. household sector once reached a peak of 2.66 trillion US dollars in November and December 2021, and will decrease by an average of 42.3 billion US dollars per month in 2022. In the first eight months of 2023, the consumption rate will further slow down to an average monthly average of 22 billion US dollars. The U.S. dollar will still be as high as 1.98 trillion U.S. dollars by the end of August 2023. The slowdown in excess savings since 2023 is largely related to the fact that the growth rate of residents’ income has remained at a high level for significantly longer than market expectations. This means that the purchasing power of U.S. residents will be higher than their income levels and pre-epidemic trend levels for a long time.
Driven by strong purchasing power, U.S. household consumption growth is still declining extremely slowly during the monetary tightening phase, and the cooling process is not irreversible. The year-on-year growth rate of U.S. retail sales has rebounded from a low of 1.3% in April to 2.5% in August, and was achieved on the basis of a very high base for three years in 2022. It is far better than the U.S. retail data expected by the market at the beginning of the year. To a large extent, it highlights the current strong purchasing power of American residents and the overheating of consumer demand.
From the production side, the continued drive of consumer demand in the overheated range, coupled with the increasingly obvious “decoupling and disconnection” industrial policy tendency of the U.S. government, has caused U.S. industrial production to continue to exceed market expectations since 2022 and continues to this day. From 2022 to the present, the Biden administration has further strengthened its policy of “decoupling and breaking links” in terms of industrial policy to win over economic allies to implement the advanced industrial chains of the United States that currently have a leading global position in China, including semiconductors, electronic integrated circuits, etc. In addition, The military conflict between Russia and Ukraine has lasted for a year and a half and there is no timetable for it to end. The performance of domestic advanced manufacturing production in the United States since 2023 has also continued to be better than PMI and market expectations. Industrial production has played an important supporting role in stabilizing and even improving the U.S. economy.
The accelerated recovery of the supply capacity of goods and services reflects strong labor demand. In addition, residents’ salary expectations have been raised after the end of the huge subsidy program. At the same time, the largest round of upward core inflation in the past 40 years has made residents particularly worried about the loss of their purchasing power. , jointly gave birth to and continuously strengthened the current “wage inflation spiral.”
During this round of QE, the speed of U.S. residents purchasing and leveraging their homes was significantly more restrained than during the real estate bubble period from 2001 to 2006. Moreover, in the two years since long-term interest rates began to rise, sales in the U.S. real estate market have cooled rapidly, thus affecting the The potential loss risk of asset quality brought by commercial banks is generally controllable. The rapid rise in U.S. long-term interest rates once caused some commercial banks that over-concentrated their assets to invest in bonds to encounter a crisis in March 2023. However, in the context of controllable real estate market risks and a slowdown in the upward slope of U.S. bond long-term interest rates, the banking industry Liquidity risks were controlled locally and prevented from spreading on a large scale.
Based on three factors, including overheating of demand caused by excessive stimulation in the early stage, the boosting effect of anti-globalization policies on short-term production and employment, and the persistence of the wage inflation spiral, the U.S. real GDP is expected to grow by 2.3% and 1.8% year-on-year in 2023 and 2024, and the U.S. economy The probability of falling into recession is low. The U.S. unemployment rate is likely to remain low at around 4% for longer, and core inflation may not approach the Fed’s latest forecast path until the fourth quarter of 2024.
We still expect the Federal Reserve to raise interest rates by another 25bp before the end of the year to maintain the current downward trend of CPI, and maintain a high interest rate policy for a long period of time to gradually reduce inflation. The first interest rate cut is expected to start no earlier than the second half of 2024, and the path of interest rate cuts is expected to be relatively smooth. The fluctuation ranges of 10-year U.S. Treasury yields and 10-year TIPS interest rates are expected to be 4.5%-4.8% and 2.3%-2.5% respectively before the end of the year. It is expected that the center of the U.S. dollar index will reach around 105.5 before mid-2024. The Fed’s hard-hawkish stance on monetary policy before the first half of 2024 may continue to put certain constraints and pressure on China’s marginal easing of monetary policy and the RMB exchange rate. We should be fully psychologically prepared for this.