BOCOM INTL: The Federal Reserve's preventive rate cuts continue, and the uncertainty of the short-term policy path is expected to increase

According to the Zhitong Finance APP, BOCOM INTL released a research report stating that the Federal Reserve is in a critical transition phase from "preventive rate cuts" to "wait-and-see," and the uncertainty of the short-term policy path is expected to increase. After the October interest rate meeting, market expectations for a rate cut in December have significantly declined—from 82.4% before the meeting to 63.8%. The December rate decision will still be data-dependent, with the core focus on whether employment data can show significant improvement after the government shutdown ends, and whether the lagging impact of tariffs on commodity inflation exceeds expectations.

BOCOM INTL's main points are as follows:

On October 30, 2025, the Federal Reserve cut rates by 25 basis points to a range of 3.75%-4.00% as expected, but the background for this decision is more complex.

Due to the U.S. government shutdown, key data such as the September non-farm payroll report were missing. The Federal Reserve chose to cut rates despite being unable to timely gauge the true temperature of the labor market, reaffirming its preventive rate cut policy orientation. Especially against the backdrop of U.S. stocks repeatedly hitting historical highs and financial conditions remaining loose, this rate cut reflects more of a "driving in fog" approach—hedging against the downside risks in employment. Although existing private sector data shows no signs of a slowdown in the labor market—initial jobless claims remain low, and job vacancy data is relatively stable, while September ADP data indicates that the job market is still slowing. Meanwhile, the continued slowdown in September CPI data did not hinder this rate cut, facilitating the Federal Reserve's decision to cut rates in line with the trend.

Divisions within the Federal Reserve are widening, and subsequent rate cuts are becoming cautious.

This rate statement included two dissenting votes: Governor Stephen Moore advocated for a 50 basis point cut, while Kansas City Fed President Esther George argued for pausing rate cuts. Subsequently, Federal Reserve Chairman Jerome Powell sent hawkish signals at the press conference, clearly stating that further rate cuts in December are "far from it," and emphasized that "policy does not follow a preset path," reflecting an increasingly cautious attitude within the Federal Reserve regarding subsequent rate cuts. Maintaining cautious rate cuts is reasonable, mainly because the current policy rate has fallen to 4%, leaving only about four rate cuts before reaching the neutral rate level of 3% that most officials consider appropriate, indicating that the restrictiveness of monetary policy has significantly eased. Against this backdrop, inflationary risks remain, and once the labor market confirms stabilization, the necessity for further rate cuts may significantly decrease.

BOCOM INTL believes that before the December interest rate meeting, the U.S. government shutdown is expected to end around mid-November, at which point the Federal Reserve will obtain November's employment and inflation data, suggesting that attention should be paid to this critical window for judging policy direction. Additionally, the recent phase of easing U.S.-China trade relations has become one of the potential positive factors, which may alleviate inflationary pressures caused by tariffs to some extent.

The Federal Reserve also announced that it will stop balance sheet reduction on December 1.

Recently, there have been clear signs of tightening liquidity in the U.S. money market: the overnight reverse repurchase balance continues to decline; the usage of the standing repo facility has increased; bank reserves have contracted; and the effective federal funds rate relative to reserve balances has begun to rise. These signs indicate that reserve levels are approaching the critical point of being "adequate." Since the start of balance sheet reduction in June 2022, the Federal Reserve's balance sheet has shrunk by $2.2 trillion, with the GDP ratio decreasing from a peak of 35% to about 21%. Therefore, the current timing to stop the balance sheet reduction is also relatively appropriate.

After stopping the balance sheet reduction, the Federal Reserve will continue to allow agency mortgage-backed securities (MBS) to mature and reinvest the proceeds into short-term government bonds, aiming to shorten the weighted average duration of the balance sheet to bring it closer to the duration structure of the circulating Chinese bond stock, thereby further advancing the normalization process of the balance sheet.

Outlook for the Future

The U.S. dollar index has recently shown signs of a phase bottom rebound. After Powell released "hawkish" signals, it is expected to strengthen further. Coupled with the backdrop of U.S. stocks operating at historical highs and the market financing leverage ratio climbing to historical peaks, market volatility risks are expected to increase significantly, which may disturb metal prices and emerging market risk assets