The Federal Reserve will review its monetary policy framework every five years. A few days ago, Powell revealed the thoughts behind the adjustments; how will the Federal Reserve cut rates, and will monetary policy continue to be loose or lean towards tightening?
First, from the subprime mortgage crisis in 2008 to 2020, the U.S. economy was in a state of three lows: low interest rates, low growth, and low inflation. During this time, the Federal Reserve mainly focused on continually lowering long-term interest rates.
Let the low-interest-rate environment stimulate economic growth. Due to the pandemic in 2021, the U.S. economy suddenly fell off a cliff, forcing the Federal Reserve to open the floodgates and release a massive amount of money, leading to inflation in the U.S.
At this point, in managing inflation, the Federal Reserve introduced the average inflation targeting policy, which tolerates inflation running a bit faster temporarily. So before it could be 1%, in the future, it could be 3%, using this method to stimulate slow economic growth. It has been proven that the Federal Reserve was still too naive; once inflation was released, it suddenly soared. U.S. inflation not only reached 3%, but also soared to 5%, with the highest core inflation hitting as high as 7%.
As a result, the Federal Reserve conducted the fastest round of significant interest rate hikes in history, with rates soaring to 525 basis points. After two years of arduous efforts, U.S. inflation not only dropped from 7% back to 2%. Now, the U.S. economy remains resilient; the story should have ended perfectly here, and Powell could be said to have achieved success and retired, leaving a mark in history.
But then came Powell's lifelong enemy, the great demon king. His sudden tariff policy disrupted all of the Federal Reserve's plans. Now, not only is the U.S. economy slowing down, but U.S. prices are also rebounding again, with the prospect of stagflation imminent.
In this case, what Powell revealed was a sense of helplessness; the new monetary framework can be described in two words: the Federal Reserve has laid flat. The Federal Reserve acknowledges that the uncertainty of the future economy has significantly increased, and it is very likely that friction among major countries will cause shortages in the U.S., rising prices, economic recession, and so on, situations that the Federal Reserve cannot manage at all.
The Federal Reserve can only formulate monetary policy more flexibly, abandoning the previously mentioned average inflation targeting, and instead acknowledging that there will be relatively high inflation in the long term. Therefore, 'higher for longer', the Federal Reserve is likely to maintain high interest rates for a considerable period in the future. It is as if Powell, before retiring, is telling the financial markets that he is really tired. The likely scenario is that the Federal Reserve will significantly weaken its control over the market and hand over the control to the king who understands and the Treasury's Basent, using their control over U.S. Treasury yields to manage the U.S. financial market, while the Federal Reserve plays a more cooperative role.
From a short-term forecast perspective, there will be 1 to 2 rate cuts this year. However, in the long term, the space for rate cuts in the U.S. has been compressed again, and the era of high interest rates will continue. So how should we respond and adjust our investment allocations in such an era? Click to follow, and Sister Bei will guide you through the rate cut cycle.
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