Source: Wind

In the past few years, the usa economy has been under the dual pressure of high inflation and policy adjustments. From the low inflation during 2021 to the soaring inflation in 2022, and gradually easing in 2023, inflation has always been at the core of usa economic policy.

With the developments of future events in the usa, the trend of the federal reserve's policies and the uncertainties surrounding future inflation trends are of great concern. Although the market previously generally expected the federal reserve to continue to cut interest rates in 2025, the pace is expected to slow down. Various signs indicate that there is still great uncertainty about whether to cut rates again in December.

According to the cme's FedWatch tool, traders have lowered their expectations for a rate cut by the federal reserve in December, with the probability of a rate cut dropping to 62.4%.

Neutral interest rate: the invisible ruler behind the policy

In the past three years, usa inflation has experienced a roller coaster change. At the beginning of 2021, the inflation rate was only 1.4%. However, due to supply chain disruptions, tight labor markets, and the impact of fiscal stimulus policies, inflation soared to 9% in June 2022, becoming the highest point in the past 40 years.

In response to soaring prices, the federal reserve implemented a series of aggressive interest rate hikes, with rates quickly rising to the highest level since 2007. This policy began to take effect, and by September 2023, the inflation rate fell to 2.4%, close to the federal reserve's target. However, the latest data shows that the inflation rate rose to 2.6% in October. Although the increase is not large, it has attracted widespread attention in the market.

This rise in inflation is not due to a one-time factor but is widespread across multiple core consumption sectors. Prices for food, energy, rent, and autos have all increased, indicating that this is not a transient phenomenon but may be the beginning of a new wave of pressure. Just a month ago, the federal reserve essentially announced victory over inflation and even initiated rate cuts to support economic growth. However, whether this resurgence indicates the return of inflation remains uncertain, as federal reserve officials have expressed many unknowns.

In the Federal Reserve's policy decisions, the neutral interest rate is a key but mysterious indicator. The so-called neutral interest rate refers to a level of interest that neither stimulates an overheating economy nor suppresses economic growth, seen as the optimal point for balancing economic growth and inflation. However, the neutral interest rate cannot be directly observed and can only be inferred through its impact on the economy.

Analysts vividly compare the neutral interest rate to an "important indicator in the financial realm." Although this concept is widely discussed, its specific level remains difficult to determine. According to Minneapolis Federal Reserve Bank President Neel Kashkari's analysis, the neutral interest rate is closely related to the productivity of the economy. If productivity structurally improves, the neutral interest rate should correspondingly be raised, which means the Federal Reserve will have less room to cut rates in response to an economic downturn.

Recently, the market has gradually accepted the view that the neutral interest rate may be higher. When the Federal Reserve first cut interest rates in September, the market expected short-term rates to drop to 2.75%-3% by the end of 2025. However, in just six weeks, the market expectation has been raised to 3.75%-4%. This change not only reflects concerns about inflation rebounding but also highlights the market's reassessment of the neutral interest rate adjustments.

The immediate priority for the Federal Reserve's policymakers is to face a tough choice: whether to continue lowering interest rates? In the November policy meeting, the Federal Reserve announced a new round of rate cuts, although the reduction was smaller, it remained consistent with the easing cycle initiated in September. However, as inflation data shows signs of a rebound, market expectations for another rate cut in December are rapidly cooling.

On one hand, the logic for rate cuts still holds. The growth of the U.S. economy is slowing, corporate investment is becoming cautious, and consumer spending growth is also decelerating. The Federal Reserve needs to support economic growth through easing policies to prevent the economy from stagnating. Additionally, fluctuations in the international economic environment and global geopolitical risks also prompt the Federal Reserve to maintain an accommodative stance.

On the other hand, the rebound in inflation poses constraints. If inflation resurges, the Federal Reserve may have to tighten policies again to prevent price instability. Some analysts believe a series of U.S. policy measures in 2025 could exacerbate inflationary pressures. For example, if new tariffs on imported goods are imposed, it will directly increase commodity costs, while changes in immigration policy may lead to labor shortages, further driving up wages and production costs. Additionally, some planned new tax cuts may also stimulate consumption, further intensifying inflation risks.

Bond market reaction: inflation expectations and long-term interest rates.

The bond market's reaction also indicates that investors' concerns about future inflation trends are intensifying. Since the Federal Reserve initiated its rate-cutting cycle, $U.S. 10-Year Treasury Notes Yield (US10Y.BD)$ Rising against the trend. This phenomenon reflects the market's adjustment of inflation expectations: investors demand higher roi to hedge against the risk of capital depreciation.

After the federal reserve began the interest rate cut cycle, the market typically expects bond yields to fall as lower interest rates usually mean reduced funding costs, which in turn drives economic growth and weakens bond yields. However, currently, u.s. treasury yields, especially the 10-year treasury notes yield, are showing an upward trend against the tide, and there are several reasons for this:

Rebound in inflation expectations: the direct driver of rising yields. Recently, u.s. inflation data has shown strong resilience. The inflation rate in October rebounded from 2.4% in September to 2.6%, breaking the previously downward trend of inflation. The market has begun to worry that the interest rate cut policy may further stimulate demand, thereby driving inflation higher again.

The relationship between inflation and bond yields is closely intertwined. When the market expects future inflation to rise, investors typically demand higher yields to compensate for the risk of declining purchasing power of money. This phenomenon is referred to as 'inflation premium', which directly leads to an increase in long-term bond yields.

Additionally, recent policy statements from the federal reserve have also reinforced market inflation expectations. Federal reserve chairman Powell mentioned in a public speech that the latest inflation data was stronger than expected, indicating that the demand side of the u.s. economy remains resilient. Against this backdrop, market confidence in the federal reserve continuing to cut interest rates has weakened, shifting to the belief that the federal reserve may maintain interest rates for a longer time or even end the interest rate cut cycle earlier. This change in policy expectations has further pushed up long-term treasury yields.

Fiscal stimulus expectations: supply pressures and market adjustments. Apart from inflation expectations, fiscal stimulus policies have also become an important factor driving up u.s. treasury yields. Some expectations for large-scale fiscal stimulus include: tax cuts and expanding public spending. While these measures aim to promote economic growth, they may also bring a series of side effects.

Fiscal stimulus is usually accompanied by an expansion of the fiscal deficit. Large-scale tax cuts and public spending will significantly increase the federal government's borrowing needs, leading to an increase in u.s. treasury supply. Under the influence of supply and demand, the increase in bond supply will lead to a drop in prices, thereby pushing yields higher.

The market is still concerned that fiscal stimulus may indirectly boost inflation. On one hand, tax cuts will increase disposable income for consumers and businesses, stimulating demand for consumption and investment. On the other hand, expanding public spending will directly increase the money circulation in the economy. This demand-side growth could lead to supply-demand imbalances, ultimately reflected in rising price levels.

Another potential consequence of fiscal stimulus is its impact on the Federal Reserve's monetary policy. If fiscal stimulus leads to an overheating economy, the Federal Reserve may be forced to tighten monetary policy again, which would further increase upward pressure on long-term bond yields.

Looking ahead to next month: interest rate cuts are not guaranteed.

With initial signs of inflation rebounding and a reassessment of the neutral interest rate in the market, it remains uncertain whether the Federal Reserve will continue to cut interest rates in December, which is also reflected in the recent performance of gold.

Last week, $Gold Futures(DEC4) (GCmain.US)$ The price dropped significantly by over 5%, to $2,567.40 per ounce, compared to the historical high of $2,801.80 on October 30, with a decline of over 8%. This price adjustment marks the most severe selling phase in the gold market since June 2021, mainly influenced by the strengthening of the USD and market expectations of a potential slowdown in the Fed's rate cut process.

Analyst Quasar Elizundia from Pepperstone pointed out that the current round of gold selling is mainly driven by a strong usd and changes in interest rate cut expectations. Previously, the market widely anticipated that the Federal Reserve would continue to cut rates to support economic growth, but the latest economic data and statements from Federal Reserve officials indicate that the pace of rate cuts may slow.

Federal Reserve Chairman Powell stated last Thursday that the latest inflation data shows stronger resilience than expected, while Boston Federal Reserve Bank President Collins further emphasized that another rate cut in December is not a certainty. A higher interest rate environment typically diminishes the appeal of non-yielding assets like gold, as investors tend to shift towards assets with higher yields like bonds.

In this context,$USD (USDindex.FX)$It continues to rise, while the u.s. treasury notes yield has significantly increased, further intensifying the pressure on the gold market. The market is reassessing the appeal of gold as a safe-haven asset, and many investors are choosing to liquidate their long positions to lock in previous profits.

Elizundia mentioned in a report that some upcoming uncertain policies will lead to further tightening of the federal reserve's monetary policy, which will adversely affect gold prices. Higher borrowing costs will suppress investment demand for gold, and changes in inflation expectations may exacerbate market uncertainties.

In addition, the extent of Trump's victory exceeding expectations has raised market concerns about the future political situation in the usa, leading to the rapid liquidation of a large number of long positions accumulated during the previous rebound in the gold market.

Adrian Ash, head of research at BullionVault, also stated that another driving factor in the current gold market is profit-taking. "After selling at the top, investors are continuing to sell gold assets during the downward process. This profit-taking is reasonable, as gold prices are still near historical highs in the range."

In the future, the trend of the gold market will still be highly dependent on the clarification of the federal reserve's policy path. If inflation data continues to show resilience, the federal reserve may maintain the current interest rate level for a longer period, or even stop cutting rates, which will put pressure on gold prices. However, if economic data shows a significant slowdown, the federal reserve may still re-accelerate rate cuts, thereby providing support for gold prices.

For the market, the key in the coming months will be the data. For investors and consumers, each upcoming policy adjustment may be a crucial point in determining the future. Will the federal reserve cut rates next month? Everything is still up in the air!

Editor/Rocky