At 3 a.m. Beijing time on Thursday, the Federal Reserve will release the minutes of its monetary policy meeting. Although the previous minutes failed to cause significant market fluctuations, at the critical time when the Federal Reserve proposed a rate cut, tonight's minutes are likely to be very important.

On the one hand, on the first trading day of the new year, the U.S. market suffered a "double kill" of stocks and bonds. Investors began to realize that the market's optimistic expectations might be too radical and the Federal Reserve is unlikely to really cut interest rates in this way.

On the other hand, the Federal Reserve’s interest rate meeting in December last year was already confusing: What exactly made Powell abandon his previous emphasis on “higher and longer”? Has the Federal Reserve already sensed the impending crisis, or is the Federal Reserve still generally hawkish, and Powell just released a “smoke bomb” to test the market reaction?

When the minutes are released, all the mysteries may be solved, and investors may have a better understanding of what prompted the FOMC to make the decision, how officials' views on the economy have changed, and which economic data policymakers prioritized when making economic forecasts.

Powell's unexpected dovish stance triggers a "rebound of everything"

At the meeting in December last year, Federal Reserve policymakers decided to maintain the federal funds rate target at 5.25%-5.50%, and hinted on the "dot plot" that the Fed will cut interest rates three times this year, and the median federal funds rate is expected to fall to 4.6% by the end of this year.

The rate cut forecast comes as inflation continues to decelerate. The headline PCE index slowed to an annual rate of 2.6% in November, down from a peak of 7.1% in mid-2022. So far, the Fed’s battle against inflation has inflicted little pain on the economy, with unemployment hovering near historic lows and growth expected to be above average last year.

The most intriguing thing was Powell's remarks at the press conference. Last month, everyone in the market was prepared for Powell to stick to the "higher and longer" expectation and believed that the Fed chairman would continue to refute the market's expectations of rate cuts.

However, Fed Chairman Powell seemed to be more dovish and brought the market a "Christmas gift." He said at a press conference on December 13 that while it is too early to say that the Fed has completely ended its rate hikes, he praised the Fed's progress in its fight to return inflation to its 2% target and did not rule out an upcoming discussion on rate cuts.

When asked about a rate cut in 2024, Powell said at the time:

“The question of when it is appropriate to start easing policy restrictions ... is starting to come into focus and it’s obviously a topic of discussion around the world and it’s a topic we discussed in our meeting today.”

The market interpreted Powell's words as "dovish", which led to a collective rebound in U.S. stocks and U.S. bonds, and U.S. bonds also ended two consecutive years of decline.

However, after Powell made his dovish remarks, many Federal Reserve officials came out to "put out the fire" and strongly refuted the market's expectations of a March rate cut, saying that the market "completely misunderstood the message the Fed wanted to convey."

New York Fed President John Williams pushed back somewhat on Powell’s comments at the time, saying Fed officials aren’t talking about rate cuts right now. “We’re very focused on the question that’s before us, as Chairman Powell said, is whether you have a sufficiently restrictive stance on monetary policy to ensure that inflation gets back to 2%.”

Investors expect twice as many rate cuts in 2024 as the Fed predicts, according to CME Group’s FedWatch tool.

Is it more likely that tonight's report will be hawkish?

TD Securities believes that although Powell has clearly hinted at the possibility of easing policy, Fed officials have denied that this is about to happen since the FOMC meeting in December last year. In this case, TD Securities expects the minutes to show that the FOMC has not yet considered the reason to cut interest rates.

Analyst Yohay Elam believes that the market may have gone too far this time. Fed officials will not want this phenomenon to continue, and the minutes released tonight are more likely to be hawkish.

Lauren Henderson, an economist at Stifel, Nicolaus & Co. in Chicago, said:

“We know that officials do expect to cut rates at least three times this year. If we see some more dovish sentiment from Fed officials, that they are comfortable with where inflation is and where it is coming down from its peak, that could solidify the Fed’s momentum for at least three rate cuts this year and increase expectations for further rate cuts.”

Henderson added, however, that “if we hear comments from Fed officials about still-elevated inflation, that could remove some of the urgency for rate cuts and the market could lower expectations for the number of rate cuts this year.”

Goldman Sachs will focus on the committee's views on the pace of the Fed's rate cuts in 2024, as Powell mentioned at a press conference that "the committee generally expects (rate cuts) to be a future meeting theme of the (FOMC). This is what happened at today's meeting."

Beware of a “reshuffle” in interest rate cut expectations!

For the market, the main risk tonight remains the repricing of the extent of the Fed's interest rate cut.

The Federal Reserve's recent changes in interest rates have driven a sharp market rebound. The market's expectations that the Fed will cut interest rates six times this year may be too "extreme", which has made some big-name fund managers nervous and believe that the market currently does not seem to have much "room for error".

Vincent Mortier, chief investment officer at Amundi, Europe's largest asset management company, said, "The message delivered by the Fed was not surprising, but the market's reaction was more surprising."

Mortier worries that this makes both stocks and bonds look vulnerable. “For the market to continue to rise, it would probably take a combination of unlikely factors to come together,” he said.

It is true that the minutes released tonight can continue the "dovish tone" of Powell's speech, which is still a good thing for US stocks and bonds. But if it is unexpectedly hawkish, the market's expectations for interest rate cuts may be "shaky" and even usher in a painful "repricing."

However, Elam also pointed out that there is no need to be afraid of hawkish minutes, saying:

"Because the Fed is still emphasizing data dependence, unless the latest data shows a tendency for inflation to rebound, there is no need to be afraid of the Fed's hawkish rhetoric."

The article is forwarded from: Jinshi Data