Zhixun Finance and Economics learned from Tianfeng Securities' research report that the US economy is entering a new normal and there is more upward risk for inflation (Fed officials expressed similar opinions). Rate cuts should be an optional element rather than a necessary one under the current circumstances. In other words, if the Fed thinks that inflation is difficult to follow, but economic growth is still on the right track and rate hikes are not within the scope of consideration, then there is no need to take action; this is also the underlying logic for not cutting rates this year.

Tianfeng Securities' main points are as follows:

US May CPI data falls short of expectations, with a total CPI increase of only 0.01% and a core CPI increase of only 0.16%, which is about half of Bloomberg's consensus forecast of 0.3%.

In terms of structure, the under-expected May CPI mainly comes from the transportation services sub-item, which fell by 0.5% this month and decreased by 1.4% from April, dragging down the overall CPI by 9bp and the core CPI by 11bp. Motor vehicle insurance and airfare prices fell the most noticeably. If the transportation sub-index remains unchanged from last month's growth rate, whether it is the overall CPI (0.10%) or the core CPI MoM (0.27%), it is close to expectations.

As a result, the US super-core inflation has fallen from a MoM increase of 0.42% to -0.04% this month, which is the first negative growth since September 2021 and is in sharp contrast to the rebound in US wage growth.

However, Tianfeng Securities believes that this CPI report may contain a considerable degree of "noise."

Compared with some "noisy" inflation data, the Fed's interest rate meeting shows a relatively hawkish side: whether the median level of rate cuts has decreased from 3 times to 1 time, further raising the year-on-year forecast for core PCE to 2.8% ( April reading was 2.75%), and continuously raising long-term rate expectations for the second time. This reflects that the Fed's response to the current inflation dynamics is relatively limited and there is uncertainty about the degree of restriction on monetary policy.

Tianfeng Securities has three main views on the current US inflation dynamics and monetary policy:

1. It is a consensus that the overall inflation level is difficult to fall this year, and the logic of Fed rate cuts lacks action.

The dot plot updated by the Fed this time raised the year-end core PCE ratio from 2.6% to 2.8%, and Powell explicitly stated at the press conference that the members are aware of the May CPI data, but most members have not modified their rate forecasts.

In other words, from the Fed's perspective, the May inflation data cannot be used as a reason to support more than two rate cuts, and more data is needed to support this; or, the May inflation data has too much "noise." The agency has already expressed its opinion at the beginning and is more inclined to the latter explanation.

If you step out of the month-over-month data, inflation is still far from the 2% target for all measures. Regarding housing inflation, Powell acknowledged that there is a longer lag in its decline. As housing inflation rebounds, the inflation level may become harder to drop.

Furthermore, a core PCE of 2.8% corresponds to a monthly increase of about 0.18%. If this growth rate is used to reverse calculate the core CPI growth rate, the year-end core CPI YoY is about 3.37%, almost the same as May's 3.41%.

Although the SEP may not necessarily be realized (and Tianfeng Securities believes that the deviation is likely to be large), understanding that the current 2.8% core PCE is equivalent to no improvement in inflation within the year is more like closing the door to rate cuts and weakening the logic of Fed action; if the Fed cuts rates, it will be difficult to be self-consistent.

2. Salary levels have not fallen with inflation, and actual incomes will drive the rebound in inflation.

The most obvious change in the past 18 months is that the slowdown in wage growth is far less than that of inflation, which has led to a continuous increase in real wage growth and has remained at a positive Year-on-year level.

Powell's press conference both recognizes that the labor market is close to returning to pre-pandemic levels and that wage growth is still too high, which Tianfeng Securities believes is more difficult to self-consistent. He gave indicators of the quit rate, job openings, and labor levels. But these three indicators returning to pre-epidemic levels precisely prove that the current US labor market has entered a new normal.

If the Fed thinks that core inflation in 2024 is 2.8% and the labor market is close to returning to pre-pandemic levels, then the agency believes that a 4% wage growth is not too high, but rather balanced.

On the other hand, Tianfeng Securities believes that there are no factors in the current US economy that simultaneously suppress wage growth and lower inflation, and supply and demand have formed a new balance. Particularly, the dependence on highly uncertain immigration on the supply side has resulted in upward risks in overall wage levels, and the substitution effect of immigration and the original labor force will cause fluctuations in the unemployment rate.

If inflation really falls, the re-increase in actual income will become the source of demand expansion, supporting the rebound in inflation; if inflation remains stable, the improvement in overall wage growth will continue to improve household income and strengthen economic resilience.

The degree of restriction on monetary policy is unknown, leaning towards "lagging action" after the economy weakens.

The Fed's consecutive second increase in long-term interest rates means uncertainty about the current degree of restriction in monetary policy, which also means that Powell is unlikely to achieve the "balanced risk" he has always spoken of due to a lack of measuring rod. Coupled with the recent volatility in U.S. economic data, the Fed may have fallen behind the curve if it wants to see sustained inflation slowdowns or labor slowdowns.

Current U.S. commercial banks have ample reserve requirements, and overall liquidity is guaranteed. Companies recorded their highest pre-tax profit levels again in Q1 2024, and their production profit margins remained at a high level of 15.7%.

Tianfeng Securities believes that to solve the problem of apparent inflation, the United States may need to start from the demand side, suppress consumer willingness to consume, and suppress corporate capital expenditures. Tax increases may be the most direct means, but without further external forces, the Fed is likely to find it difficult to define the node of "preventive" interest rate cuts, and a more cautious approach is to wait for the economy to fully weaken, but there are no signs of that right now.

Based on the above three points, Tianfeng Securities believes that the U.S. economy is entering a new normal, with more upside risks to inflation (Fed officials have expressed similar views); interest rate cuts are optional, rather than necessary, in the current environment.

In other words, if the Fed believes that inflation is difficult to subside but the economy is still on the right track for growth and interest rate hikes are not under consideration, then there is no need for action, which is the underlying logic of not cutting interest rates this year.

The Fed is currently in a difficult position. Tianfeng Securities quotes a passage from Burns' testimony before Congress in February 1973 as the conclusion:

"The appropriate role of monetary policy in achieving national economic objectives is relatively limited. It can help to create a large financial environment where price stability and economic prosperity are achievable. However, monetary policy cannot guarantee the ultimate desired results: This task (for monetary policy/Central Bank) is too large."

Risk Warning: The U.S. labor market weakening more than expected, U.S. unemployment rate rising more than expected, and high U.S. interest rates being maintained for a longer period of time.