Core Viewpoints

We believe that the Federal Reserve, viewed from the perspective of its "dual mandate," still lacks the urgency and necessity to lower interest rates. The strong consumption data further confirms that the Fed is not behind the curve, and we infer that the dovish expectations for the Jackson Hole meeting are likely to be unfulfilled. Should the Fed decide to cut rates, the ample liquidity, coupled with the "loaded bow" of the credit cycle and the ongoing recovery in business confidence, could quickly transmit effects to the U.S. economy. Moreover, there is still ample fiscal space (with a pro-expansion fiscal stance already demonstrated in July), and the determination of the Democratic Party to make a last-ditch effort for the upcoming elections.

After the release of data on non-farm employment, job numbers, and retail sales, the market has begun to focus on the August Jackson Hole Symposium of central banks. There is anticipation for Powell's latest views on the U.S. economy, more structural guidance on U.S. monetary policy, and the release of some dovish signals.

We believe that essentially, only one question needs to be answered: What is the true state of the U.S. economy?

Overall, the U.S. economy continues to grow amidst the intensifying divergence between the service and manufacturing sectors. The service sector remains robust; manufacturing, although facing dual pressures of high interest rates and destocking, is more prevalent on the production side; durable goods consumption, represented by automobiles, remains at a healthy level; and the overall economy continues to show a "soft landing" trend.

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In the labor market, the disconnect between unemployment and employment persists, contradicting the historical cyclical trends before recessions; a significant increase in illegal immigration adds to the supply, weakening the predictive power of "Say's Law" derived from the demand side.

Inflation is increasingly driven by housing and hindered by used cars, distorting the signals conveyed by the data. The divergence between the historically low core goods year-over-year growth rate and the rebounding PPI will eventually converge; it is more likely that the former will converge towards the latter, meaning that a significant deflation in goods is not sustainable.

Therefore, we maintain that the Federal Reserve, from the perspective of its "dual mandate," still does not have the urgency or necessity to lower interest rates. The strong consumption data further confirms that the Fed is not behind the curve, and we infer that the dovish expectations for the Jackson Hole meeting are likely to be unfulfilled.

Should the Fed decide to cut rates, the ample liquidity, coupled with the "loaded bow" of the credit cycle and the ongoing recovery in business confidence, could quickly transmit effects to the U.S. economy. Moreover, there is still ample fiscal space (with a pro-expansion fiscal stance already demonstrated in July), and the determination of the Democratic Party to make a last-ditch effort for the upcoming elections.

The "recession trade" has come and gone, and the U.S. stock market has largely recovered the losses incurred during the process, with consumer data released during this period being particularly strong.Taking the hotel and airline industries as the most representative examples: under comparable conditions, the hotel occupancy rate is nearly flat compared to the past two years, and the Revenue per available room (RevPAR) has further increased compared to 2023; in July, the total airline revenue grew by 4.9% year-on-year, and the number of passengers carried grew by 9.9%.

If we look at the broader retail consumption, after experiencing the "trough" in April, recent retail data fully demonstrate the resilience of U.S. consumption. Especially in July, the three main measures of retail data continued to exceed expectations, with the control group retail MA3 annualized growth rate, which is included in GDP, continuously increasing since February.

The fervor of consumption is in stark contrast to the slowdown of inflation, as U.S. consumers are also pursuing "value for money," but "value for money" does not mean not consuming. The greatest confidence in consumption comes from the continuous appreciation of residents' wealth, and behind the wealth are two important supports: the U.S. stock market and real estate. The importance of the U.S. stock market to consumption is self-evident, and the impact of U.S. real estate on consumption is also significant—according to IMF estimates, since the pandemic, U.S. real estate has driven more than 50% of U.S. consumption.

In addition to the previous unemployment rate of 4.3%, other labor market data do not point to a slowdown. For instance, the number of people applying for unemployment benefits for two consecutive weeks was lower than expected; the number of job vacancies published by Indeed did not decrease after entering July, and wage growth has bottomed out, reflecting that the demand for hiring by companies to date remains healthy.

The steady demand for hiring is backed by the fact that corporate financial pressures are still at a sustainable level. Since 2021, net interest expenses have not increased significantly but have actually decreased, which is also the biggest difference from previous cycles. Companies with abundant cash flow choose to deposit short-term and borrow long-term during interest rate inversions, benefiting from the high short-term rates, which has also led to a significant increase in corporate gross margins.

Finally, we would also like to refute the view that the decline in inflation raises real interest rates. The one-year real interest rate calculated by swaps has decreased and is close to the lowest level of the year, which also corresponds to the continuous easing of the adjusted financial conditions (FCI-G) published by the Federal Reserve. However, the term spread of the short end of the real interest rate has been narrowing, and caution is needed to prevent an inversion of the real interest rate curve.

In summary, we believe that the market is "doubly optimistic," overestimating both the extent of the Fed's rate cuts and the decline in inflation. Therefore, for the upcoming Jackson Hole Annual