Does the Fed vote not to "drop"?

Does the Fed vote not to "drop"?

This article from the micro-channel public number: Guotai Junan Securities Research (ID: gtjaresearch), Author: Guotai Junan total team head diagram from the visual China

Judging from Powell's testimony to Congress yesterday, the Fed seemed to show another sign of a "drop" in the market.

On the one hand, the Fed believes that inflationary pressures have not emerged. On the other hand, due to trade disputes and weak economic momentum in the world's major economies, the uncertainty of the US economic outlook has also increased in the past two months.

In addition, the Fed has also shown some concerns about the government's policies:

Some government policy issues have not yet been resolved, including trade development, the federal debt ceiling and Brexit. And there is a risk that weak inflation will last longer than we currently expect. We are following these developments closely and will continue to assess their impact on the outlook for the US economy and inflation.

Regarding trade issues, the Fed believes that:

Significant progress in trade has shifted to greater uncertainty, and our reports on business and agriculture have raised concerns about trade development. Growth indicators from around the world are disappointed with growth, raising fears that the weakness of the global economy will continue to affect the U.S. economy. These concerns could lead to a decline in business confidence in some recent surveys and may have begun to show transmitted data.

Mr. Powell's attitude in his testimony raised expectations of the“cutinterest rate” at the end-of-month negotiation meeting, but could the testimony really represent the Fed’s attitude of the“datadepends”?

Why does the Fed put "pigeons"

In fact, before the meeting, the Fed’s internal, Fed and market differences were huge.

Before the Fed did not move, but the dovish voice was booming. Judging from the Fed's statement and dot matrix, there is a big controversy within the Fed, and the market expectation from the fund rate futures reaction gives the probability of a rate cut of nearly 100% in July.

Historically, however, interest rate futures forecasts are not always reliable.

For example, from 2009 to 2016, the market expects the interest rate to increase. However, the actual situation is that the Fed continues to remain inactive. In this case, in 2008 and 2009, in the Fed’s rapid cut interest rate, the market has experienced “false judgment” of interest rate increase. .

If you plot the actual federal funds rate trend and the interest rate trend implied by interest rate futures on a historical chart, it can be seen that historical policy changes have been inflected, and in most cases, the market is more radical than the Fed; Expectations of the Fed’s interest rate policy will often “make mistakes” and sometimes even long-term biases.

Deviation between market expectations and real federal funds rates, data source: Torsten Slok's full June Economic Chart Book

This is because the federal funds rate futures are only the result of "transactions." The core and most sensitive indicator of interest rate policy is the non-agricultural employment of the US private sector.

We have investigated the sufficient and necessary conditions of interest rate reduction in the statistical law of non-agricultural employment since 1994.

1. Continued slowdown in non-agricultural employment (necessary but not sufficient conditions)

The non-agricultural mean value of the three months prior to the interest rate cut is greater than the first six months. Source: CEIC, Guotai Junan Securities Research

The non-farm average for the first three months of the rate cut was below 50 cents (163000) since 1994. This time, the three-month non-farm average for April and May was 178000 and 195000, respectively, still above 50 digits.

Non-agricultural employment quartile comparison table since 1994, data source: CEIC, Guotai Junan Securities Research

two。 Non-agricultural negative growth in one month or more (close to sufficient conditions)

Since 1994, non-agricultural employment has experienced negative growth for 62 months and cut interest rates by 26 times. Except for August 1997, non-agricultural negative growth in a single month fell within the interest rate cut. In fact, after the non-agricultural growth in August 1997, interest rate cuts occurred in September 1998.

Treasury interest rate VS Federal Fund rate, data source: Wind, Guotai Junan Securities Research

So, in June, the expected non-farm data was out, and the interest rate cut in the market was expected to fall.

Has the interest rate cut in July been reached?

1. The job market is slowly weakening and there is no significant deterioration in pressure

After the non-agricultural data in May was significantly lower than expected, the number of new non-agricultural data employment in June was 224,000, significantly higher than the expected 160,000.

Taking into account unemployment, wage growth and other aspects, we think the U. S. labor market is still in a steady state.

In June, the unemployment rate rose 0.1 percentage points to 62.9 percent and 3.7 percent, respectively. Since 2014, the labour force participation rate has fluctuated within about 0.5 percentage points of about 63 percent. The significance of raising 0.1 percentage points in June remains to be seen, while the unemployment rate, even if it rises to 3.7 percent, is still at an all-time low. Combined with unemployment rate, the increase in labor participation rate can explain a certain degree of increase in unemployment rate.

Non-agricultural data fluctuate greatly, adding 224,000 people in June, better than expected, data source:Guotai Junan Securities Research, Wind.

In addition, the salary growth rate was unchanged from the previous value of 3.1%, which was less than the expected 3.2%, and has not increased to the previous high (2.4% in February).

Specific items to see:

In the service industry, the information industry is the most bright (5%), the increase of the production and the private service industry is equal to that of the previous value of 2.7%, 3.2% of which only the transportation equipment is up to 3.6% (the previous value is 3.1%), and the other major industries have lower salary growth rate; in the service industry, the information industry is the most bright (5%). 3.6% of the previous value, 3.9% for public utilities, 3.7% for financial activities, and 3.8% for leisure and hotel industry are still the fastest-growing industries.

2. The US economy is fundamentally down and down

U.S. manufacturing PMI has been volatile since the second half of 2018, with the latest PMI falling back to its lowest level since October 2016 in June.

In contrast, GDP growth is down, inflation is weak, industrial output, investment, consumer confidence index falls.

However, despite the decline in the consumer confidence index, retail sales fluctuated steadily and did not deteriorate significantly. Retail sales in May rose by 0.5% qoq (previous value -0.2%).

3. Monetary policy: interest rate cuts need to wait patiently until the fourth quarter

Referring to our June 11 topic, conditions and Catalysts for Fed interest rate cuts, and taking into account the job market, financial markets and inflation levels, we do not think the conditions for a rate cut in the third quarter are mature.

At present, the Fed is worried that under the low nominal interest rate, the interest rate policy space is “insufficient” and cannot be used rashly. However, the market is not fully aware of this.

Powell has emphasized:

"when central bank interest rates are close to the zero limit, it is more effective to respond to policies when there is a real potential recession."

At present, the Fed's 2.5 per cent interest rate is below the 5 per cent interest rate level in 2008. In the Chicago speech, Powell also stressed that.

At the same time, through the summary of historical experience, we also find that interest rate cuts are not imminent.

By counting the Fed policy interest rate data since 1982, we found that after the end of the interest rate hike, the time to cut interest rates for the first time was not long, with an average of 3.5 months. Five of them were interest rate cuts within one month after the rate hike (a total of 12 counts), and the longest was 15 months before the interest rate cut in 2007.

At this moment, the Fed has raised interest rates for six months in December 2018. From the time point of view, there is the possibility of a rate cut at each subsequent meeting. At the same time, it is also necessary to take into account the time required for the Fed's policy assessment.

In summary, the weakening of the job market, the sluggish inflation and the increase in the volatility of the financial market have prompted the need for easing, and the current easing of financial conditions has reduced the urgency of easing.

Therefore, we expect the Fed to cut interest rates under the influence of uncertainties in trade and elections. However, the interest rate cuts may have to wait until the fourth quarter, rather than the third quarter, which is strongly expected by the market.

What happens if I don’t cut interest rates?

Looking back at history, if the Fed does not cut interest rates in July, it will not be bad for US stocks.

Historically, every time the Fed actually went loose, U.S. stocks fell, and the logical clue behind it was that the Fed began easing, which meant that the U.S. economy was under greater downward pressure or at risk of recession, and that the deterioration of growth and earnings expectations became the main contradiction in the market and suppressed the stock market.

At present, as the Fed Chairman Powell expressed in his answer to the reporter's question, the economic signals of the United States are still relatively complicated, and there are certain contradictions between the data. It is still difficult to determine that the US economy has a large downward pressure.

Data contradiction in the United States: strong Employment and weak PMI, data Source: Wind, Guotai Junan Securities Research

This means that the stock market investors mean that the economy has not deteriorated for a while, but the interest rate level represented by US Treasury bonds has already fallen, and the three logics supporting US stocks can continue. Therefore, if the Fed does not cut interest rates in July, US stocks may not be bearish.

For A shares, A shares themselves in the market environment and operation, did not show loose pricing. From the point of view of monetary policy independence between China and the United States, the spread of interest rates on 10-year Treasury bonds between China and the United States has exceeded 100 BP, exceeding the "comfort range" of about 80~100bp mentioned by President Yi Gang.

Sino-US spreads give more independence to domestic monetary policy (% bp), data source: Wind, Guotai Junan Securities Research

Therefore, if the Fed does not cut interest rates, it will not restrict domestic monetary policy, but it can promote the opening of domestic policy, mainly in two logical chains:

The Fed’s interest rate cut means that the US economy is declining, bringing economic fundamental pressure on domestic transmission; the linkage of China-US central bank policies and the further opening of policy space for China.

If the Fed cut interest rates in July, Chinese investors need to balance the possible US-share adjustment, domestic policy easing, the RMB exchange rate and the international capital flow, and it is considered that the dollar index is weak due to the limited increase in the recent A share, The adjustment to the Unit is expected to be relatively limited to the impact of the A-share.

A-share investors need to pay more attention to the repair of domestic policy mix, economic growth and profitability.

In the bond market, the Sino-US bond market is not so surprised by this “unexpected surprise”.

For US bonds, according to the term structure theory of interest rates, long-end interest rates can be regarded as the superposition of expected short-and medium-term interest rates, reflecting more expectations of future interest rates.

In the initial stage of interest rate cut, reflecting the expected long-end interest rate pre-price in interest rate cut expectations, fast downward, but the short-end interest rate has not yet been fully started, at this time the biggest differentiation, the curve limit upside down position should appear in the month or the month before the rate cut.

Inverted limit often occurs at the time of interest rate cut, data source: Wind, Guotai Junan Securities Research

It is recalled that the last five interest-rate cuts have been initiated, with a limit of 125 bp, an upside down, and an 18 per cent limit to the federal fund's interest rate level at that time. The magnitude of the fall should be proportional to the "length" of the expected future rate cut.

If the Federal Reserve interest rate meeting does not cut interest rates in July, for the current fund interest rate of 2.3~2.4%, the limit ratio method is used to estimate that the limit position of 10Y US debt is about 2% (2.4% × (1-18%), similar The 2.3% federal funds rate corresponds to the 1.9% national debt limit position). Compared with the current 10Y US debt, the downside space is already limited.

In China's domestic bond market, the internal cause is the main contradiction of the current trend. The Fed is the weather vane of the global central bank's actions, but compared with the US debt rate clearly followed by the Fed operation, the performance of China's national debt is affected by the Fed and there is no simple and clear rule.

Since 2002, the Fed has experienced two cycles of interest rate hikes and interest rate cuts. With the exception of the interest rate cut cycle after the subprime mortgage crisis in 2008, interest rates on Chinese Treasuries are in line with the Fed's monetary policy. In the other three cycles, the trend of Chinese bonds is not necessarily linked to Fed policy:

From 2002 to 2003, the interest rate cut cycle, the trend of China Bonds fluctuated sideways; 2004-2006, the Federal Reserve raised interest rates, the domestic bond market yields fell sharply; 2016 to date, the interest rate cycle, the Chinese debt first down.

On the whole, the Fed's interest rate operation can't directly influence the trend of the middle-debt, and the "internal cause" is the main contradiction of the trend of middle-debt.

The Fed policy has limited impact on the trend of Chinese government bond yields. Source: Wind, Guotai Junan Securities Research

The above contents are excerpted from the securities research report issued by Guotai Junan Securities, "if the Fed does not cut interest rates in July," and "abnormal fluctuations in agriculture, interest rate cuts need to wait patiently until the fourth quarter." Please refer to the full version of the report for specific analysis (including risk tips, etc.). If there is ambiguity in the excerpt of the report, the full version of the report shall prevail.

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This article is from WeChat official account: Guotai Junan Securities Research (ID:gtjaresearch), author: Guotai Junan Total team, head picture from visual China

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