The focus of the current market has shifted from 'Will there be a rate cut in September?' to 'How significant will the rate cuts be in the coming years?' The key to all of this lies in the 'dot plot' released by the Federal Reserve in September.
Next, let's break it down step by step:
1. Background: Why is market sentiment tense?
Imagine a summer where the weather is hot and stuffy (high interest rate environment), and everyone is looking forward to a refreshing downpour (rate cut) to cool things down. Previously, everyone predicted that the first rain in September would definitely come.
Expecting a cooling: But in recent weeks, the weather forecast has changed. Data shows it doesn't seem as stuffy anymore (inflation has eased but remains stubborn), so people are starting to doubt: 'Can it still rain in September?' Some even worry that if it doesn't rain at all, will the crops (economy) in the fields die of drought (recession)? — This is the process of the market transitioning from discussing 'whether or not to cut rates in September' to 'whether the U.S. economy is in recession.'
"Worries about good news being fully priced in": Morgan Stanley's view is like saying, "Even if it really rains in September, it might just be a big sound with little rain, and once it stops, the drought will continue, leading to greater disappointment and a market decline." This is a typical investment psychology of "buying expectations and selling facts."
The situation won't be that simple, because in addition to the announcement of whether it will "rain" in September, there is something more important—the future "rain plan," which is the dot plot.
Two, core game: Trump vs. Federal Reserve
A very crucial point: this is not merely a game of economic data, but more like a power game.
Trump's goal: He wants a big and urgent downpour (rapid and large rate cuts). Why?
Low interest rates can stimulate the economy, making the stock market more prosperous, which is beneficial for his election.
Low interest rates can reduce the pressure on the government to repay huge debts.
Therefore, he will continue to exert immense pressure on the Federal Reserve, ignoring some complex data and only demanding one result: cut rates quickly and significantly.
The Federal Reserve's goal: It acts like a meticulous hydraulic engineer, aiming to adjust the water flow (interest rates) steadily and controllably, with the goal of:
Primary task: Completely cure the stubborn disease of inflation (bring inflation steadily back to 2%).
Secondary task: Ensure the economy does not collapse because of "taking medicine" (high interest rates) (avoid triggering unnecessary recessions).
Therefore, the Federal Reserve's attitude will inevitably be conservative and cautious; it hopes to have solid evidence that inflation has been defeated before gradually loosening interest rates. It does not want to be swayed by politics.
Although the Federal Reserve is independent, it has 12 voting members whose views are not completely unified. This gives Trump space for "lobbying" and "pressure."
Three, the ultimate answer: What is the "dot plot"? Why is it so important?
The dot plot is not a complex chart; you can understand it as: the "anonymous voting results" of the Federal Reserve's big shots on future interest rate predictions.
Each point on the chart represents a committee member's belief about where interest rates should be at the end of the year. This chart directly tells us the Federal Reserve's official interest rate expectation path.
All of the current anxieties in the market are guessing how this "plan" will be written. Two extreme scenarios:
Scenario 1: Doves win big (Trump's goal)
The dot plot shows: 3 rate cuts possible in 2025 (0.75%), and another 8 cuts in 2026 (2.00%).
Market interpretation: "A big flood is coming!" This means that the Federal Reserve will not only start cutting rates soon but will also continue to significantly loosen monetary policy in the future. Funding costs will become very low, which is very beneficial for corporate investment and stock market rises.
Market reaction: Highly likely to cheer for an increase. This exceeds the market's current conservative expectations (only 1-2 rate cuts in 2025), providing the market with a long-term and clear optimistic signal.
Scenario 2: Hawks dominate (the Federal Reserve's conservative tendency)
The dot plot shows: As in June, there will only be 2 rate cuts in 2025 (0.50%), and another 2 cuts in 2026 (0.50%).
Market interpretation: "It's over, life is going to be tight from now on." This means that the Federal Reserve believes inflation is more stubborn than previously thought, and interest rates will remain high for the next few years. High rates will continue to suppress corporate profits and economic vitality, increasing the risk of recession.
Market reaction: Highly likely to be a pessimistic decline. This is equivalent to shattering the market's expectations for future "easy and prosperous days," and what Morgan Stanley refers to as "good news turning into a decline" is very likely to come true.
You can understand it this way:
Will there be a rate cut in September = Will it rain this week?
Dot plot = A weather forecast for the entire year ahead
Of course, everyone is concerned about this week's weather, but what really affects your decision on "whether to farm or build a reservoir" is the long-term weather forecast.
Thus, the September meeting, a rate cut of 25 basis points itself may only meet expectations; what can truly ignite the market or extinguish hope is that "dot plot" weather forecast. It reveals whether the "significant easing faction" has the upper hand or if the "cautious conservative faction" still dominates the situation.
The outcome of this tug-of-war between "Trump" and the "Federal Reserve" will be clear on this chart.