Before the Fed meeting, we analyzed the central bank's statements under the three potential paths of **, neutral and hawkish. Yesterday the Fed made it clear that a rate cut in March is not a baseline scenario, which is equivalent to choosing a hawkish path with a low probability.
It is important to note that the Fed has not completely ruled out a rate cut in March, and the final policy choice will depend on the economic data in the coming months: the meeting decision states that "the Fed will not cut rates until it is confident of seeing inflation return to its 2% target". Powell suggested that a significant cooling of the labor market or a significant improvement in inflation is needed to make it possible to adjust policy more quickly. These positive factors for changing policies are actually accumulating:
CICC's model shows that U.S. inflation will continue to improve in the first half of 2024, and 2With a CPI of about 5% and a PCE of about 2%, the Fed has a relatively fast chance of reaching its inflation target. The just-released ADP data was significantly lower than expected, indicating that the labor market and economic growth are also slowing, and a non-linear cooling of the economic downcycle cannot be ruled out. It is difficult to judge the severity of the problem at present, but it at least suggests that the financial system is relatively fragile in the context of high interest rates, and it may also form a negative cycle with the economic downturn.
From the perspective of policy logic, the Fed does not want to see the market trade interest rate cut expectations in advance, so the decision to cut interest rates is usually sudden: before December last year, although we repeatedly warned that "higher for longer" is not credible, and the Fed will not delay the rate cut until the second half of 2024, and it is recommended not to underestimate the timing and pace of the Fed's interest rate cuts, the mainstream view of the market is still "higher for longer". It wasn't until the Fed's interest rate meeting in December turned dovish that the "higher for longer" view quickly collapsed. Taking history as a guide, we cannot rule out the possibility that the Fed will quickly adjust its views after changes in the economic environment.
The market expects that the probability of a rate cut in March has dropped to 35%. We think a rate cut is still possible in March, but it is no longer very strong** and needs more data to back it up. Our judgment on the general trend of the market is completely unaffected: the interest rate cut trade is still the main line, and we are bullish on US Treasuries**. No rate cut in March has been priced in by the market, and if the Fed finally chooses to cut interest rates in March, it will be good for Treasuries**. If the Fed does not cut interest rates in March, it is likely to cut interest rates in May, and the delay in the timing of interest rate cuts for 2 months will have a limited impact on the general market trend.
The 10-year Treasury rate has now fallen to 395%,* up to $2,046, the rate cut trade progressed slightly faster than we expected. Although the lower than expected ADP is good news, we still suggest that the uncertainty of the non-farm payrolls data on Friday is high, and it is difficult to judge the direction of the market, and it is recommended to further increase the position and cut interest rates after the non-farm payrolls risk is eliminated.