Cautious Rate Cuts by the Federal Reserve

On February 11, local time, Federal Reserve Chair Jerome Powell appeared before the Senate Committee on Banking, Housing, and Urban Affairs to present his semiannual monetary policy testimonyDuring this hearing, Powell emphasized the issue of inflation, indicating that there was no rush to adjust interest ratesThis statement further hinted that the Federal Reserve would maintain patience regarding any potential rate cuts in the near future.

Powell's cautious language during the congressional testimony reflects the Federal Reserve's prudent approach given the current economic landscape and ongoing uncertainties surrounding policy decisionsThe chair acknowledged the robust performance of the U.S. economy but sidestepped certain sensitive topics, suggesting that the uncertainties accompanying the new administration's initial period have influenced the Federal Reserve’s policy-making processWith details about trade tariffs, tax reforms, and other policies yet to materialize, the Federal Reserve remains unable to accurately assess how such measures might impact the economy and inflation, leading to a more cautious stance.

Currently, inflation in the United States is still above the 2% targetGiven the potential for new tariff policies and possible retaliatory measures from other nations, there remains a risk of inflation continuing to climbTherefore, it appears reasonable for the Federal Reserve to delay any further rate cuts for now.

This cautious attitude from Powell aligns with the recent inflation expectations surrounding U.S. tariff policies, painting a somewhat hawkish image of the Federal ReserveOn the same day of Powell's testimony, U.STreasury yields rose once again, with the 10-year Treasury yield—the so-called "anchor" for global asset pricing—climbing back above 4.5%. The U.S. dollar index also slightly retreated from its highs, hovering around the 108 mark.

Interest rate cuts by the Federal Reserve must carefully weigh the balance between the U.S. economy and inflation

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Despite the resilience of the American economy, inflationary pressures remain a concern, especially with the implications of policies regarding illegal immigration potentially affecting the labor marketThis may lead to increased labor costs and possibly trigger a wage-price spiralFurthermore, potential tariff measures could introduce imported inflationWith so many influencing factors at play, the Fed’s demeanor reflects a hawkish perspective.

Moreover, caution is warranted, as former Treasury Secretary Larry Summers has warned that the Federal Reserve's next move could very well be an interest rate hikeWhile such a scenario may still be unlikely at present, it is not outside the realm of possibility given the prevailing uncertainty in economic data.

Overall, Powell's remarks indicate a predominantly cautious tone, suggesting that a return to interest rate cuts may not transpire soon.

While acknowledging the resilience of the American economy, Powell chose to sidestep discussions regarding tariffs, the specific role of Tesla's CEO Elon Musk within the government, and safety concerns surrounding bank accounts—all issues that reflect the uncertainties accompanying the nascent administrationHe reiterated that with the overall strength of the economy and low unemployment rates, combined with inflation still above the 2% target, the Federal Reserve is not in a hurry to lower short-term rates again.

Other Federal Reserve officials have expressed similar watchful perspectivesCleveland Fed President Loretta Mester indicated that it would be prudent to hold rates steady for some time as policymakers await further declines in inflation and analyze the economic effects of the new administration's policies. "We've made significant progress, but the goal of 2% inflation is not yet visibleAs long as the labor market remains healthy, we will seek substantial evidence that inflation can sustainably return to that level before making any further adjustments to policy," she stated.

Mester also pointed out the uncertainty surrounding government policies, particularly in relation to regulations, taxes, immigration, and tariffs, noting that it would require "some time" to evaluate and determine an appropriate monetary policy response. "For instance, when considering tariffs, it is sensible to be patient in assessing their ultimate impact

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Given the historically high inflation rates recently, the risks associated with inflation trends seem to tilt towards the upside, which could delay the return to the 2% inflation level and further amplify the economic impacts of high inflation," she remarked.

The Federal Reserve's "third-in-command," New York Fed President John Williams, also conveyed that he anticipates inflation will continue to moderate toward the Fed's target of 2% but acknowledged that policy uncertainty casts a shadow over the economic outlook. "A moderately restrictive policy stance should support the return of inflation rates to 2%, while also maintaining robust economic growth and labor market conditionsHowever, it is essential to note that the economic outlook remains highly uncertain, particularly regarding potential fiscal, trade, immigration, and regulatory policies," Williams explained.

While the U.S. labor market has shown signs of cooling, it remains fundamentally strongWilliams projects an inflation-adjusted economic growth of around 2% for 2025 and 2026, with price increases expected to hover around 2.5% this year and only gradually decline to 2% over the next few years.

However, the risk of interest rate hikes remains a pivotal concernFour years ago, Summers criticized U.S. fiscal and monetary policy makers for excessive stimulus, which he feared could lead to the largest inflation surge in decades, a prediction that seems to have materializedNow, Summers warns of the risks of renewed price pressures. "Since the policy missteps of 2021 sparked serious inflation, we have arrived at a particularly sensitive moment for inflation escalation," he stated, citing signs of a tightening job market, which includes significant wage growth reported in January employment data, a situation that could lead to a potential uptick in consumer pricesFollowing this warning, the U.S. announced a series of tariff policies.

Consequently, Summers emphasized the need for extreme caution concerning inflation, urging the Federal Reserve to remain vigilant about price pressures

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He believes further interest rate cuts might not be advisable in the current cycle and warned that the Federal Reserve's next step could be an interest rate hike instead.

Summers' caution highlights the potential risks of sharply rising inflation and a renewed upward trajectory for interest ratesWhile the prevailing market consensus suggests that the Federal Reserve will continue to cut rates, the high uncertainty surrounding economic data and policies leaves the possibility of changeIf future economic indicators suggest persistent inflationary pressures, the Fed might resort to rate hikes to curb inflation. "Ultimately, it hinges on forthcoming data and the Federal Reserve's assessment of the economic landscapeHowever, based on potential tariff policies that could significantly impact the U.S. economy, the likelihood of an imminent rate hike appears relatively low," Summers remarked.

The chief economist at Apollo Global Management, Torsten Slok, has also cautioned that the market could face jolts this summer, possibly manifesting as interest rate hikes from the Federal ReserveHe argues that U.S. tariffs will exacerbate inflationary trendsSlok predicts a possible rate hike during the Fed's mid-June meeting as a result.

Slok further noted that if inflation accelerates following the implementation of tariffs, multiple rate hikes may be anticipated later in the yearSuch developments could catch the market off guard, as participants currently harbor the belief that the Fed will either refrain from further cuts or keep rates steady for the time being without factoring in the likelihood of rate increases.

At present, Summers and Slok's viewpoints remain somewhat unconventional, and the probability of rate hikes in the short term seems limitedThe likelihood of a return to an interest rate hike cycle appears lowUnlike conditions during the oil crisis of the 1970s, the current landscape shows that overall energy prices are fluctuating, but pressures from non-OPEC+ supplies might ease inflation moving forward as the U.S. ramps up production.

Moreover, although the U.S. economy retains its resilience, the support mainly stems from fiscal measures, while leverage among businesses and households remains low

Thus, to alleviate fiscal constraints, the U.S. needs to ensure the flow of creditConsequently, the outlook for rate cuts by the Federal Reserve has not altered, with the timing of such cuts possibly shifting based on macroeconomic data.

The 10-year Treasury yield has once again topped 4.5%. Federal Reserve decision-makers express concern over various American policies, such as tariffs and mass deportations of illegal immigrants, which economists generally believe could exacerbate inflation within the U.SAccording to Deutsche Bank, even the tariffs on steel and aluminum could lead to a 0.4 percentage point increase in the core PCE price indexOn February 11, the hawkish Federal Reserve pushed the 10-year Treasury yield back above the 4.5% mark; concurrently, the dollar index remained robust.

The uncertainty surrounding tariffs and the reignited risk of inflation could significantly influence the marketTariff uncertainties may escalate trade tensions, affecting both corporate investments and consumer confidence, ultimately placing a strain on economic growthSimultaneously, the resurgence of inflation risks could stimulate expectations in the market for the Fed to delay interest rate cuts, intensifying market volatility.

Looking ahead, opinions regarding U.STreasuries appear neutralThey still promise reasonable yields at maturity; however, the room for downward movement in Treasury yields may be constrained by the decreasing scope for rate cuts, indicating that capital gains on bonds may be limitedAs for the dollar, based on the impacts of U.S. tariffs and the resilience of the American economy, it might stay relatively strong in the short termHowever, in the longer term, under the backdrop of potential Fed rate cuts, the dollar's performance could weaken slightly.

It should be noted that the rising expectations for inflation previously propelled the 10-year Treasury yield to 4.8% in January—the highest level since late 2023—before retreating to 4.54%. Moreover, the dollar index has seen slight declines thus far this year.

History may well be repeating itself

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