CICC: The Federal Reserve lowered interest rates by 25 basis points as expected, and the stimulus effect of this round of rate cuts may be weaker than in previous cycles

According to the Zhitong Finance APP, CICC released a research report stating that the Federal Reserve is expected to cut interest rates by 25 basis points at the October meeting, but Powell's remarks are clearly more "hawkish," suggesting that a rate cut in December is by no means a certainty. The bank believes this indicates that the view supporting a pause in rate cuts is gaining traction within the Federal Reserve. Looking ahead, although the Fed still has some room for easing, the pace of rate cuts may slow down, and overly optimistic expectations should be avoided. Meanwhile, the stimulative effect of this round of rate cuts may be weaker than in previous cycles, partly due to a significant weakening of the "refinancing effect." The Federal Reserve also announced that it would end quantitative tightening (QT) in December, which the bank believes is more due to technical considerations and should not be overinterpreted; given that there is still considerable room for lowering the policy rate, the necessity of purchasing unconventional financial assets is not significant.

CICC's main points are as follows:

The Federal Reserve cut interest rates by 25 basis points at the October meeting, in line with market expectations. In this decision, two officials voted against it: Governor Mulan advocated for a 50 basis point cut, consistent with Trump's call for the Fed to lower rates; Kansas Fed President Schmidt argued for keeping rates unchanged. This reflects that divisions within the Federal Reserve are intensifying. The monetary policy statement did not change much from September: employment growth has slowed this year, and the unemployment rate has risen, but remains low; inflation has risen since the beginning of the year and is still at a high level.

What truly disturbed the market was Powell's "hawkish" stance on whether to cut rates in December. He pointed out at the press conference, "A further reduction in the policy rate at the December meeting is not a foregone conclusion, far from it." He further stated that the Fed cut rates in September due to a weak labor market, but "the logic going forward is a different thing." He also mentioned that there were clear divisions among Fed officials on how to act in December during the discussions of this meeting.

The bank believes Powell's remarks indicate that the internal support for pausing rate cuts in December is gaining momentum. Further, this tendency may be based on two main considerations:

First, the labor market is slowing but not deteriorating rapidly. Powell pointed out that initial jobless claims, ADP employment data, and other private sector indicators all show that employment growth is slowing, but there are no signs of a rapid decline. In other words, the premise for continuing to cut rates is a rapid deterioration in employment conditions, and whether this condition will be met by December remains to be seen.

Second, inflation is still significantly above the Fed's target. Although the impact of tariffs on prices has not been as severe as previously expected, inflation levels have remained on the rise in recent months. According to the Fed's estimates, the PCE inflation rate in September may be 2.8%, up from 2.7% the previous month. Additionally, the Fed's credibility in achieving its inflation target is increasingly being undermined—inflation has been above the 2% target for five consecutive years, and the capital markets have even popularized the notion that "3% is the new 2%." The statement reflects the upward risk in market inflation expectations. The bank believes that in this context, it is both necessary and strategic for the Federal Reserve to maintain a certain hawkish stance in its decision-making.

Looking ahead, the bank believes that although the Federal Reserve still has room for further policy easing, it should not be overly optimistic about the pace. After this rate cut, the federal funds rate has fallen to a range of 3.75% to 4.0%, which is still above the bank's estimated neutral rate level of 3.5%, indicating that overall monetary policy remains relatively tight. However, as the policy rate approaches the neutral range and inflation levels remain stubborn, the pace of rate cuts may slow down. One possible change is shifting from "cutting rates at every meeting" to "cutting rates once a quarter," adjusting the policy rate to neutral or slightly accommodative at a slower pace.

At the same time, expectations for the stimulating effects of rate cuts should be kept cautious. One channel through which rate cuts affect the economy is the "refinancing effect"—when interest rates fall, mortgage holders can refinance to reduce repayment costs, thereby increasing disposable income and stimulating consumption. However, since the rate cuts in 2024, this effect has been notably limited. One piece of evidence is that the Mortgage Bankers Association (MBA) refinancing index has not risen significantly as it did in past rate-cut cycles. The main reason is that a large number of homebuyers locked in ultra-low rates in 2021, thus lacking the motivation to refinance. On a macro level, this means that the current round of rate cuts may have a weaker impact on the real estate market and interest-sensitive consumption compared to previous cycles, and the upward momentum of this financial cycle will also be lower than in the last two financial cycles.

In terms of the balance sheet, the Federal Reserve announced that it will end quantitative tightening (QT) on December 1. At that time, the monthly reduction of USD 5 billion in U.S. Treasury securities will stop, and the principal due will be reinvested; the monthly cap of USD 35 billion for mortgage-backed securities (MBS) will continue to be enforced, but the principal due will be reinvested in short-term Treasury bills (T-bills).

The bank believes that ending the balance sheet reduction is more of a technical adjustment, driven by two main considerations: first, to respond to market concerns about tightening liquidity and to prevent a repeat of the funding market volatility caused by excessive balance sheet reduction in 2019; second, from the perspective of asset duration management, the Federal Reserve aims to reduce the average duration of its asset portfolio, gradually shifting holdings from long-term MBS to short-term Treasury bills. This move also reflects the Federal Reserve's intention to promote the "normalization" of policy, as traditional monetary policy primarily relies on open market operations rather than purchasing unconventional financial assets. Therefore, the bank expects that the Federal Reserve will not easily restart quantitative easing, especially since there is still room for lowering the policy rate, making it unnecessary to stimulate the economy through asset purchases