Moneta Markets Daily News

Historic Dilemma Reappears

The latest minutes from the May FOMC meeting show that the Federal Reserve's decision-makers are facing the most complex policy dilemma since 2008. The repeated mention of "difficult trade-offs" in the records is effectively an official confirmation of the stagflation scenario of "inflation and unemployment rising simultaneously." Officials unanimously believe that current economic "uncertainty has reached unprecedented heights," marking the first time in nearly a decade that such a strong risk warning has appeared in meeting documents.

Details of the meeting revealed that Federal Reserve staff have rarely assessed the probability of economic recession alongside baseline growth forecasts. Models show that if the Trump administration implements the originally planned 145% punitive tariffs on China, U.S. GDP could shrink by 0.8 percentage points within three months. Business surveys indicate that supply chain restructuring has irreversibly increased cost pressures, pushing up end prices. Minneapolis Fed President Kashkari bluntly stated in discussions, "Tariff shocks are creating long-term structural wounds, the impact of which far exceeds short-term data fluctuations."

More noteworthy is the explicit manifestation of divisions among decision-makers. Some officials attribute inflation to the formation of a "wage-price spiral," while another faction emphasizes the destruction of business confidence due to "policy inconsistency." This divide was glaringly exposed during the unusual movements in the U.S. Treasury market in April—where the ten-year yield broke the crucial threshold of 4.5%, triggering warning signals for corporate financing costs. Estimates from the Cleveland Fed show that for every 1 percentage point increase in yields, interest expenses for highly indebted firms will consume 15% of their operating profits.


The Dollar System is Shaking

Discussions in the minutes regarding the "change in the dollar's safe-haven status" reveal the Federal Reserve's deeper anxieties. A report from the New York Fed indicates that global central banks sold U.S. Treasuries in April at the highest level since 2016, while gold holdings surged by 8% during the same period; this shift in asset allocation is eroding the foundation of monetary policy transmission.

The deterioration of liquidity in the bond market has become a major concern for decision-makers. The minutes particularly emphasize the need to "continuously monitor bond market volatility" due to the failure of U.S. Treasuries as a global pricing benchmark, which has led to a tightening of the Financial Conditions Index (FCI) by 23 basis points in the first two weeks of May. Data from JPMorgan shows that the spread between corporate bonds and government bonds has widened to levels seen during the March 2023 Silicon Valley Bank crisis, indicating that credit tightening may arrive sooner than expected.

More severe is the risk of unanchoring inflation expectations. The Boston Fed's consumer survey found that the median inflation expectation for the next three years has risen to 3.4%, the highest since September 2022. This self-fulfilling vicious cycle is a core feature of the stagflation of the 1970s.


The Three Diverging Paths of the June Meeting

Based on clues from the minutes, the June interest rate meeting may face three policy choices, each of which would trigger completely different market tremors: First, a hawkish hold, maintaining the interest rate range of 4.25%-4.5%, but signaling long-term tightening through the dot plot. This move aims to suppress inflation expectations but may exacerbate bond market sell-offs. Data from the Chicago Mercantile Exchange shows that the futures market assigns a 78% probability to this expectation, but Goldman Sachs warns that if the unemployment rate simultaneously breaks above 4.5%, the risk of a simultaneous stock and bond market crash will increase sharply.

Second, preventive rate cuts. Proactively lowering rates by 25 basis points to save jobs. Minutes show that some officials believe "the risk of excessive tightening is rising," but current market pricing reflects only a 2% probability of a rate cut. Morgan Stanley estimates that such a policy surprise could trigger a 3% plunge in the dollar index.

Third, unconventional toolbox. Implement distortion operations (OT) or targeted QE to alleviate pressure on long-term rates. Meeting records show that Federal Reserve staff have updated emergency plans, but Deutsche Bank points out that such a move may be interpreted as a confirmation signal of policy failure, triggering a correction of 10%-15% in risk assets.

"Powell is walking on the thinnest policy tightrope in history." According to Peterson Institute for International Economics Director Blanchard, "The June meeting may be forced to choose between the inflation monster and the abyss of unemployment, and regardless of the choice, the market needs to buckle up." Currently, federal funds rate futures indicate that the cumulative interest rate cut expectation before the end of 2025 has narrowed from 175 basis points in March to 40 basis points.

This document, referred to by the market as the "most dovish hawkish minutes in a decade," is essentially a crisis warning letter. When the central bank issuing the world's reserve currency begins discussing "trade-offs," and cracks appear in the foundation of the U.S. Treasury-Dollar system, investors need to re-evaluate all assumptions of asset pricing. The June meeting may not immediately trigger a crisis, but it is destined to become a key turning point in the post-Bretton Woods era.


Overview of other data, meetings, and events

U.S. Economic Data: On Thursday, the annualized GDP for the first quarter and the quarterly Personal Consumption Expenditure Price Index for the first quarter will be released; on Friday, the monthly and annual Personal Consumption Expenditure Price Index for April will be announced.

Japanese Economic Data: April retail sales year-on-year will be released on Friday.

China's Economic Data: On Saturday, the official manufacturing and non-manufacturing Purchasing Managers' Index (PMI) for May will be released.

After the U.S. International Trade Court ruled on May 28 to suspend the implementation of the Trump administration's tariff increase policy announced on April 2, the Trump administration has filed an appeal.

HP's U.S. stock plummeted nearly 15% after hours as the company lowered its earnings forecast due to increased costs from tariffs. The company reported net revenue of $13.22 billion for the second fiscal quarter, slightly above analysts' expectations of $13.14 billion; it expects adjusted EPS for the year to be between $3.00 and $3.30, while analysts had expected $3.50, and the company had originally projected $3.45 to $3.75.


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