TF Securities: The "rate cut trade" by the Fed may be too optimistic

According to the Wise Finance APP, TF Securities released a research report stating that the current "rate cut trade" regarding the Fed is heating up, with even bets on a rate cut in July. However, the logic behind the entire "rate cut trade" is not solid: it is based solely on seemingly weak employment and inflation, overlooking the still strong consumption and underestimating the fiscal stimulus and the Fed's patience.

This round of "rate cut trade" is mainly driven by the continuous rise in the unemployment rate and CPI falling below expectations. In previous reports, we clearly expressed the view that recent US employment and inflation data do not actually support a rate cut.

In summary:

• Regarding employment, the most obvious feature of the current US labor force is that "the rise in the unemployment rate is not accompanied by a decline in the employment rate." In the previous two recession cycles (2000 and 2008), there was a decline in the employment rate. Therefore, there is no need to overly worry about the rise in the unemployment rate.

• Regarding inflation, the current US inflation data is disconnected from demand, with the most obvious drag coming from cars and oil, where demand is not weak but faces their own heterogeneity. Changes in seasonal adjustment factors post-pandemic have lowered recent core inflation month-on-month readings, thereby exaggerating the cooling of US inflation.

• The latest June retail data, whether overall, core, or control group data, all significantly exceeded expectations. Most sub-items saw month-on-month growth rates surpassing the previous month; core retail sales in June increased by 0.8% month-on-month, while control group retail data included in GDP increased by 0.9% month-on-month.

Considering that around 15,000 car dealerships were affected by network supply issues in June, dragging down overall retail by 0.4%; if the affected sales are included, it is evident that retail sales are recovering month by month.

More broadly, consumer spending has shown a trend of continuous recovery in May and June after being disrupted by tighter financial conditions in April. This corresponds to the definition of retail sales, proving the resilience of the US economy.

When US residents shifted from excess savings-driven consumption in the early stages of the pandemic to wage-driven consumption, consumers may now prioritize value for money, but valuing money does not necessarily mean consuming less.

High-frequency data related to travel also shows strong demand. TSA security checkpoint numbers exceeded 3 million people in a single day for the first time in history, fuel-related demand remains high, refinery capacity utilization is at historically high levels, and US same-store sales profits are on the rise.

Even sectors highly sensitive to interest rates, such as manufacturing and real estate, have stabilized to some extent. US real estate starts and building permits in June did not further decline under high rates; manufacturing and industrial output have also exceeded expectations for two consecutive months.

All the above data stand in opposition to the "rate cut trade." The Atlanta Fed's GDPNow model's latest estimate predicts that the US real GDP for Q2 2024 will be at an annualized rate of 2.73%, indicating that US economic growth is still above potential growth levels In addition to strong consumer support for the "rate cut trade", the US PPI and import price index also rebounded more than expected, pointing to greater inflationary pressure. Considering that the current share of commodity consumption in the US is higher than pre-pandemic levels, and consumption is higher than the trend level, the transmission of overall inflation through commodity prices by PPI and IPI will be more pronounced than before the pandemic.

The current extreme betting on rate cuts is no different from the beginning of the year. While overall CPI is close to the beginning of the year, actual wage growth has experienced 6 months of positive growth, continuing to grow positively year-on-year for 14 consecutive months, while household wealth in the past six months has further appreciated (stock market and real estate).

Apart from economic data, the Fed in an election year tends to "talk more and do less" to avoid unnecessary attention.

Recently, Trump stated in an interview that he "does not want to see a rate cut before November." We also pointed out in April that an early rate cut may seem favorable to the Democratic Party on the surface, but it may decouple inflation expectations. (See "The Fed Should Not Cut Rates Unnecessarily") Cutting rates before the election may lead to faster economic transmission than inflation rebound, which is why Trump, who favors low interest rates, is preventing the Fed from cutting rates.

From the Fed's perspective, while independence is important, the current trend changes in employment and inflation are putting it in a more favorable position, and there are still sufficient reasons not to cut rates; the Fed daring to "do nothing" before the election can also demonstrate its "independence" courage.

We have mentioned many times that in the context of rising neutral interest rates, the Fed's room for rate cuts is relatively limited. Keeping the less restrictive high rates for a little longer can provide a clearer path for rate cuts in the future, and expectations are more important than actions.

Finally, the fiscal space for the last quarter of FY2024 (the third quarter of the 2024 calendar year) in the United States remains relatively ample. In the first 9 months of the 2024 fiscal year, non-interest expenditures of $4.3 trillion have been recorded, with $1.6 trillion of non-interest expenditure remaining in the last 3 months.

We must not forget that the US election is not just Trump vs. Harris (Biden), but also Republicans vs. Democrats. Democrats have sufficient reasons to increase fiscal spending - for election campaigning, to preserve political legacy, and to secure greater economic benefits for the party.

On July 11th, Biden announced a total of $1.7 billion in subsidies to multiple car manufacturers to update production lines related to new energy vehicles. Democrats are further strengthening fiscal efforts in the field of new energy, which Republicans clearly oppose, with a very clear logic behind their actions - highlighting policy differences with Trump, fulfilling political commitments, killing two birds with one stone.

Discussing "transitory inflation" in 2021 and "economic hard landing" in 2022-2023 fundamentally underestimates the resilience of the US economy under a strong dollar. The current "rate cut trade" seems to be making the same mistake, and we must not underestimate the determination of Democrats to increase fiscal spending before the election as a final gamble