On October 9th local time, the Federal Reserve released the minutes from its September interest rate meeting. The minutes revealed that there was still disagreement within the Federal Reserve about cutting interest rates by 50 basis points (bp) against the backdrop of the U.S. economy not showing a significant recession.

In the September Federal Reserve interest rate decision, 11 out of the 12 voting members of the Federal Open Market Committee (FOMC) voted in favor of a 50 bp rate cut. However, several participants noted that a reduction of 25 bp would be in line with the gradual path of policy normalization.

A substantial rate cut by the Federal Reserve is not the norm, and the balance sheet reduction may continue for some time.

Advertisement

The Federal Reserve minutes indicated that the FOMC believes that the upside risks to the U.S. inflation outlook have diminished, while the downside risks to employment are considered to have increased. Most officials thought the downside risks to employment had increased, but some officials did not believe there was a significant risk of further substantial weakening in labor market conditions.

Moreover, there was disagreement among the officials about the degree of policy restrictiveness. Some officials believed that assessing the degree of policy restrictiveness had become complicated due to the uncertainty of the long-term neutral interest rate level, and therefore, it was appropriate to gradually reduce policy restrictions. Officials who supported a 50 bp rate cut believed that against the backdrop of falling inflation and persistently weak employment, a rate cut should have been implemented in July, and thus September should make up for the easing that should have been implemented in July. Some officials who supported a 50 bp cut acknowledged that they could also support a 25 bp rate cut. The larger rate cut approved at the meeting should not be seen as a signal of concern about the economic outlook. A substantial rate cut is not the norm and should not be seen as a signal that the Federal Reserve is prepared to rapidly cut rates.

The FOMC believes that the importance of communication lies in clearly conveying that the committee's monetary policy decisions depend on the evolution of the economy and its impact on the economic outlook and the balance of risks, and therefore, no predetermined path is set. Future monetary policy will continue to follow the data-dependent rule. If inflation can continue to fall, the policy rate will gradually return to a neutral level. Even if the committee lowers the target range for the federal funds rate, the process of reducing the Federal Reserve's balance sheet may continue for some time.

The market continues to adjust expectations for aggressive rate cuts by the Federal Reserve.

After the minutes were released, the market continued to adjust expectations for aggressive rate cuts by the Federal Reserve. According to the CME Group's "FedWatch" tool, the probability of the Federal Reserve cutting rates by 25 bp by November has risen to 86.7%, with a 13.3% chance of keeping the current rate unchanged. The probability of a cumulative 50 bp rate cut by December is 78.1%, a cumulative 75 bp rate cut is 10.1%; and a cumulative 100 bp rate cut is 0%.

Combining the latest U.S. economic data, a soft landing for the U.S. economy and a gradual decline in inflation remain the macro mainline of the U.S. economy. In addition, the U.S. election voting has already ended before the Federal Reserve's interest rate meeting in November, and it is expected that November and December are more likely to shift to a single 25 bp rate cut.

The recently released U.S. non-farm data for September greatly exceeded expectations, with 254,000 new non-farm jobs added in September, higher than the revised 159,000 in August, far exceeding the market's general expectation of 150,000, and the unemployment rate dropped to 4.1%, the lowest since June 2024. After the release of the September employment report, the market reduced bets on substantial rate cuts by the Federal Reserve in the follow-up.A research report from ICBC International points out that one of the main reasons for the Federal Reserve's significant interest rate cut in September was to prevent the labor market from slowing down too much. In September, the US non-farm data was comprehensively better than expected. Under such circumstances, the necessity for the Federal Reserve to continue cutting interest rates by 50 basis points in November has significantly weakened. If the labor market continues to remain strong, the subsequent interest rate cuts by the Federal Reserve will also be significantly narrowed.

The chief macro analyst team of Caitong Securities, led by Chen Xing, believes that there is still one non-farm employment data release before the Federal Reserve's interest rate meeting in November. Considering the strong momentum of the labor market and the economy, it may not weaken rapidly in the short term, and the Federal Reserve's interest rate cuts may be more cautious. The Federal Reserve is more likely to cut interest rates by 25 basis points in November.

The macroeconomic team of Minsheng Securities pointed out that in September, the increase in US non-farm employment far exceeded expectations, and the probability of slowing down the interest rate cut pace to 25 basis points in November has risen rapidly. From historical experience, after the interest rate cut cycle starts, employment data still becomes the focus, but it will decrease as the interest rate cut cycle deepens, and the sensitivity of various assets to employment data will also decrease. At the same time, during this process, the market's expectations for interest rate cuts will also be gradually corrected: generally speaking, about 3 months after the start of the interest rate cut cycle, the market will have a conclusion on whether it is a "soft landing" or a "recession".

The current market is gradually forming a consensus on the soft landing of the US economy, and it may only be missing an employment report. If the employment data in October is better than the market's expectations again, the market's "consensus" on the soft landing may be formed.

The market's current expectation for the amplitude of this round of interest rate cuts is more than 200 basis points, which is actually more aggressive than the amplitude of interest rate cuts in previous soft landings: in the three rounds of soft landings in 1995, 1998, and 2019, the final interest rate cut was only 75 basis points. Considering that the current market expectations are in a state of "neither soft landing expectations nor recession expectations", if the economy does indeed achieve a soft landing later, the current market greatly overestimates the future amplitude of the Federal Reserve's interest rate cuts, then there will be pressure for US bond yields to rise again, and US stocks will have a better performance.