Galaxy Securities December FOMC Meeting Review: Mildly Dovish Rate Cut, Increasing Internal Divisions.

China Galaxy Securities released a review of the December FOMC meeting. On December 11th, the Federal Reserve lowered the benchmark interest rate by 25 basis points to 3.50%-3.75%, in line with market expectations, with a cumulative rate cut of 75 basis points for the year. Since this rate cut was already priced in, the market's focus was not on the rate itself, but on Jerome Powell's tone, the policy path reflected in the dot plot, adjustments in economic forecasts, and whether they would initiate asset purchases similar to QE. Powell's statements in the press conference were overall dovish. China Galaxy Securities' main points are as follows: Rate cuts were priced in advance; the market is more concerned with incremental information: The Federal Reserve lowered the benchmark interest rate by 25 basis points to 3.50%-3.75% on December 11th, in line with market expectations, with a cumulative rate cut of 75 basis points for the year. Since this rate cut was already priced in, the market's focus was not on the rate itself, but on Jerome Powell's tone, the policy path reflected in the dot plot, adjustments in economic forecasts, and whether they would initiate asset purchases similar to QE. Key point one: The December statement emphasized the rise in the unemployment rate. The overall assessment of the economy and inflation did not change, still indicating that economic activity is expanding at a moderate pace, inflation has risen slightly from the beginning of the year and remains relatively high. There was a slight adjustment to the language on employment, removing the previous description of "remained low," and changing it to "employment growth has slowed, and the unemployment rate has edged up," indicating weaker resilience in the labor market as a direct reason for the rate cut. Additionally, when discussing adjustments to the target range for the federal funds rate, the statement added the wording "of the magnitude and timing" of the adjustment. Key point two: The December statement announced the initiation of balance sheet expansion. The statement noted that the committee judged that banks' reserve balances had fallen to near adequate levels, and therefore, they would begin purchasing short-term Treasury securities as needed to maintain an abundant supply of reserves. Combining Powell's explanations during the press conference and the arrangements disclosed by the New York Fed's open market operations desk, the Federal Reserve would begin purchasing $40 billion in Treasury securities monthly starting in December, with expectations of maintaining a high level of purchases in the coming months, followed by a gradual decline. This operation falls under reserve management purchases (RMP) to maintain the reserve management framework, rather than quantitative easing (QE). Additionally, restrictions on the use of the overnight repo facility were lifted to provide additional security for short-term liquidity. Key point three: There was an expansion in internal dissension within the Federal Reserve. The dissent was reflected in both the voting on the decision and the dot plot. (1) In terms of voting, three out of the 12 voting members opposed the 25 basis point rate cut. Stephen Milne advocated for a 50 basis point rate cut; Jeffrey Schmidt and Austin Goolsby supported keeping rates unchanged, with Goolsby being the first to join the opposition camp. (2) Regarding the dot plot, 19 Fed members had more varied opinions on the rate path for 2026. Compared to September, the number of members who believed there should be one rate hike in 2026 increased from two to three; those who believed rates should remain unchanged decreased from six to four; those who believed there should be one rate cut increased from two to four; those who believed there should be two rate cuts remained at four; those who believed there should be three rate cuts decreased from three to two; those who believed there should be four rate cuts decreased from two to one; and there was one person who predicted there should be six rate cuts (none held this view in September). Key point four: The central tendency of the dot plot for December did not change. The median expected federal funds rates for the end of 2025, 2026, 2027, 2028, and the long-term remained consistent with the September expectations at 3.6%, 3.4%, 3.1%, 3.1%, and 3.0% respectively. Key point five: GDP growth forecasts were raised in December, while inflation expectations were lowered slightly and unemployment rates were adjusted slightly. (1) The median GDP growth rate estimates for the end of 2025, 2026, 2027, and 2028 were 1.7%, 2.3%, 2.0%, and 1.9%, respectively, compared to 1.6%, 1.8%, 1.9%, and 1.8% in September, all of which were raised. (2) Core PCE inflation expectations were 3.0%, 2.5%, 2.1%, and 2.0%, compared to 3.1%, 2.6%, 2.1%, and 2.0% in September, some of which were lowered. (3) PCE inflation expectations were 2.9%, 2.4%, 2.1%, and 2.0%, compared to 3.0%, 2.6%, 2.1%, and 2.0% in September, some of which were lowered. (4) Unemployment rate expectations were 4.5%, 4.4%, 4.2%, and 4.2%, with the only change being in 2027, where the rate was lowered from 4.3% to 4.2%; the rest of the years remained consistent with the September forecasts. Key point six: The December dot plot showed that there was only one rate cut space remaining in 2026. The December dot plot indicated that the Federal Reserve only had one 25 basis point rate cut expected for 2026, with another rate cut expected in 2027. As of 6 am on December 11th Beijing time, CME market pricing still reflected the possibility of two rate cuts in 2026, one each in April and September, with no rate cut arrangements for 2027. If there are no risks of unexpected declines in the U.S. labor market and economic data, the expectation of two rate cuts in 2026 will be maintained. Key point seven: Powell's statements at the press conference were overall dovish. (1) Powell pointed out that employment growth has significantly slowed, estimating that recent job growth has been overestimated by about 60,000 jobs per month, leading to a potential negative growth rate. Family perceptions of employment opportunities are declining, and labor supply is sharply decreasing, emphasizing the need for policies to not continue to suppress job creation. (2) Powell stated that core PCE inflation over the past 12 months was 2.8%, mainly reflecting the return of commodity inflation due to tariffs; if tariffs were excluded, inflation would be just over 2%, and the tariff effects are expected to peak around the first quarter of next year. (3) Powell explicitly stated that the current interest rate level is positioned close to neutral, and during the Q&A session, he mentioned that no one view of raising rates was the baseline scenario, with most of the Board's divergence focusing on whether to remain at the current level or make a slight further decrease. Key point eight: The Federal Reserve faces a change in leadership at the regional and chairman levels in 2026. (1) The current voting system consists of seven governors and four rotating regional bank presidents, with a new round of annual rotations for regional bank presidents scheduled for February 2026, including Anna Paulson from the Philadelphia Fed, Beth Hammack from the Cleveland Fed, Lori Logan from the Dallas Fed, and Neil Kashkari from the Minneapolis Fed, who will replace the current presidents of the Boston, Chicago, St. Louis, and Kansas City Feds on the FOMC voting list. (2) Fed Chairman Jerome Powell's term as chairman will officially end on May 15, 2026, and President Trump has the complete nomination authority. If he is not re-nominated or confirmed by the Senate, he will step down as chairman but can continue to serve as a governor until 2028. (3) The range of potential Fed chair candidates has narrowed down to five individuals, including current governors Bowman and Waller, White House National Economic Council Director Hassett, former governor Warsh, and BlackRock's head of fixed income Reid. Polymarket shows that Hassett's nomination probability is significantly leading. Key point nine: Front-runner Hassett indicates that there is still room for rate cuts. (1) From an academic background perspective, Hassett holds a Ph.D. in Economics from the University of Pennsylvania, studied under Ohlbach, served in the Federal Reserve Board's research department, and has worked at the American Enterprise Institute for a long time, specializing in areas such as taxation, investment, and energy. He is a strong supporter of supply-side tax cuts and market pricing mechanisms, with sufficient academic and technical qualifications. (2) From a political background perspective, he is a core executor of Trumponomics, leading and vigorously promoting tax reduction legislation, and cooperating with political narratives attacking statistical agencies and the Federal Reserve. (3) Given that the Fed chairman does not have veto power, reshaping the FOMC relies on slow nomination and rotation mechanisms. Even if Hassett takes office, he can only push forward Trump's desired significant rate cuts by convincing the governors and regional Fed presidents. In this regard, he still differs from Greenspan and Powell. Firstly, there is already significant internal dissent within the FOMC, and secondly, it takes time to establish trust and working relationships. Therefore, even in the short term, if the "Hassett era" begins, the Fed's policy orientation is more likely to be slightly dovish at the margin, making it difficult to immediately shift to political accommodation. Key point ten: Bullish for risk assets and gold, bearish for the dollar. (1) Due to the Fed's balance sheet expansion and Powell's dovish turn, the U.S. Dollar Index fell by 0.60% to 98.65; the 10-year U.S. Treasury yield dropped by 3.51 basis points to 4.149%, while the 2-year U.S. Treasury yield fell by 7.24 basis points to 3.538%; the Nasdaq index rose by 0.33%, and the S&P 500 rose by 0.68%; spot gold closed up by 0.48% to $4,228.55 per ounce. (2) Looking ahead to 2026, in the context of synchronous declines in nominal interest rates and inflation, the 10-year U.S. Treasury yield is expected to fall to the 3.8%-4.0% range; Japan's expected rate hikes and the end of the euro's rate cutting period are expected to significantly weaken the US Dollar's interest rate advantage, with the U.S. Dollar Index expected to test around 95; COMEX gold futures target range may be upwardly adjusted to $4,300-4,500 per ounce; overall accommodative environment for U.S. stocks remains supportive, but differentiation will intensify. Risk warning: 1. Risks of unexpected downward surprises in U.S. labor market and economic data; 2. Risks of unexpected liquidity problems in the U.S. banking system; 3. Risks of Trump's policies unexpectedly stimulating inflation.