The Fed has been expected to raise interest rates ahead of schedule since December.The core reason is that inflation in the United States has been high since November last year.For the fifth month in a row, CPI was above 5%, and in March, CPI 8.5% and PPI 11.2%, all of which were at historic highs.

Controlling inflation is the central task of the Fed, especially in the mid-election year, where there is a strong political incentive to curb inflation, and dovish Fed officials are turning eagles.

So since December, the Fed has been raising interest rate deflation expectations in advance, putting bad things ahead while the economy and markets can afford it, using hawkish signals to dampen inflation expectations as much as possible.

Hawkish expectations have reached their climax. According to the market expectation of raising interest rates to 2.50-2.75% this year, we use the FRB/US model to calculate that the interest rate hike will have an impact of nearly 1 point on the growth rate of US GDP. Coupled with the contraction of US $1.1 trillion, the US economy will have a "hard landing".

This is the first stage of the expectation of raising interest rates.In the early stages of austerity, hawkish expectations tend to be overstrong, resulting in overreaction in the market and overshoot in interest rates on US debt.

So at some point the Fed needs to change its attitude of raising interest rates.The change is based, first, on a year-on-year decline in inflation data, and secondly on signs of recession in economic data.

The expectation of raising interest rates is past its peak. Although it was the first time that an one-off interest rate hike in May was seen since May 2000, Powell basically dismissed the possibility of an one-off interest rate hike 75bp at a press conference, and the scale of the shrinking table gradually increased from $47.5 billion to $95 billion, rather than in one step.

Recent inflation figures are moderating marginally, and then the likelihood that the Fed tightens more than expected is declining.Us core PCE growth fell 0.1 per cent year-on-year in March compared with February. Earlier announced, core CPI rose 0.1 per cent in March compared with February, but the growth rate was also significantly slower, with core CPI falling for three consecutive months.

Core inflation reflects residents' real disposable income, and core inflation, especially the weak prices of core consumer goods, shows that high oil prices are eroding residents' real spending power.

We estimate that for every $20 / barrel increase in oil prices, real disposable income growth will decrease by about 0.66%, real consumption growth except food and energy by 1.04%, and real GDP growth by 0.94%.

The main contribution of non-core inflation comes from the rise in crude oil prices.Recently, the price of crude oil has fallen by about $30 from its peak of $130 in early March, although it does not rule out the possibility that prices will rise again during the peak demand season in July-August, but the crude oil market has basically priced the war between Russia and Ukraine.

On the supply side, Germany has a clear timetable for the ban on Russian oil imports, but some European countries have clearly considered using the rouble for oil and gas transactions with Russia, and the supply premium brought about by the war between Russia and Ukraine has declined.

On the demand side, oil and gas has entered the off-season demand for energy products, electricity demand in Europe has begun to decline, and the containment of the epidemic in China's Yangtze River Delta region has reduced China's crude oil consumption demand by about 10%. The pricing logic of crude oil is shifting from stagflation expectations of supply disturbances to recession expectations of weakening demand. If global demand weakens further, oil prices will still adjust.

The US economy has entered an inflection point of marked deceleration. In the first quarter, the annualized rate of GDP turned negative-1.4% compared with the previous value of 6.9%, which was the first negative turn since the epidemic in 2020.

The main negative contributors to the slowdown were inventory investment and net exports, followed by government spending. Although the structure of household consumption and corporate capital expenditure is relatively good, the description of the economy is as a whole, and the decline in inventory investment reflects that high oil prices are affecting retailers and channels' expectations of future demand. the deep negative growth in net export growth is also the result of high oil prices increasing the trade deficit, and the sharp decline in fiscal spending support to the US economy will be difficult to reverse before this year's election.

A "soft landing" is the Fed's good hope, but it is not realistic.The economic soft landing in the two interest rate raising cycles of 1965 and 1984 avoided recession in the context of fiscal loosening, while the 1994-1995 interest rate hike cycle, which was both tight in money and finance, corresponded to the "blonde" economy in the 1990s.

Compared with that time, the current US economy faces the triple pressure of weaker fiscal support, inflation eroding household income and consumption, and residential and industrial investment, and the economy is more likely to enter a recession next year.

If exogenous conditions worsen further (raising interest rates too quickly or high oil prices last longer than expected), the recession could be brought forward to the end of this year.

Therefore, if the Fed fully meets its expectations of raising interest rates, there is a high probability that the US economy will have a "hard landing", a recession is approaching, and tightening policy will face a reversal under the "dilemma".

Interest rate hikes are expected to enter the second phase. Inflation moderated inflection point appeared, the economy began to show signs of deceleration, tightening expectations fell back, closer to reality, tightening landed but in line with expectations.

In the later stage of raising interest rates, inflation falls, the economy slows obviously, and signs of recession begin to appear. Tightening expectations may turn and enter the third stage of raising interest rates. At this time, monetary policy may undergo a transition of tightening first and then loosening.Similar to the policy path from the end of 2018 to the first half of 2019.

Interest rate hikes are expected to slow in Q3.Generally speaking, three to six months after the Fed begins the interest rate hike cycle, there will be so-called brakes to reassess the economic situation and the negative impact of interest rate hikes on the economy to determine whether rapid interest rate increases are needed in the next stage. whether the contraction table needs to slow down.

The key to the turn is that inflation is significantly lower than the same period last year, followed by signs of recession. At present, the period from June to July is the time for the year-on-year growth rate of core inflation to further confirm the inflection point, which may be the inflection point of events such as the war between Russia and Ukraine and the epidemic in Shanghai, as well as the intensive disclosure period of US economic data and US stock market reports in the second quarter.

This is a critical window, and if inflation falls faster than the same period last year, it may be time for the Fed to start to change its attitude.

Q4 may stop raising interest rates.After 10 years and three months of debt upside down since 1985, the probability of recession is 60%. After the upside down, the Fed has stopped raising interest rates.

Historically, rapid interest rate cuts by the Fed after 10 years and three months of debt upside down have been an effective way to avoid recession. According to the current Fed 275bp interest rate hike expectations, the US bond yield will be between 2.33% and 2.58% in the three months to the end of the year, which is close to the long-end Treasury bond interest rate of 2.5% predicted by the FRB/US model in the three quarters after the rate increase, and the 10-year Treasury bond and the three-month Treasury yield will be upside down.

This means that the Fed needs to stop raising interest rates on Q4 this year, and a safer option is to start cutting interest rates immediately after hanging upside down to avoid a recession.

According to the historical law of past interest rate raising cycles, the Fed usually stops raising interest rates about a year or more before the recession begins, so even according to the benchmark model of raising interest rates, the Fed needs to stop raising interest rates by Q4 this year at the latest.