CICC: Maintaining the benchmark judgement that the Federal Reserve will not lower or raise interest rates within this year.

Zhongjin released a research report stating that the seasonally adjusted month-on-month increase in US CPI in May was 0.5%, with a year-on-year increase of 4.2%, the highest level since 2023; core CPI rose 0.2% month-on-month, with a year-on-year increase of 2.9%. This inflation was mainly driven by the energy sector, with gasoline and fuel prices leading the way. The transmission effects of ticket prices and express delivery services continued to be evident, but not widespread. Overall, core inflation remained moderate, with demand in oil-sensitive sectors such as automobiles being squeezed, and rent increases narrowing significantly. The current inflation is still mainly driven by structural factors such as energy shocks, and cyclical inflation is not yet prominent, but caution is needed against the risk of a rebound in total demand brought about by the expansion of AI capital expenditure and improvements in employment. In terms of monetary policy, the benchmark judgment is that the Federal Reserve will not cut interest rates or raise them within the year. It is expected that the Fed's attitude will remain hawkish, and after Powell takes office, the primary task will be to restore policy credibility, more likely by strengthening expectations of balance sheet reduction rather than signaling an interest rate hike to show determination. There is a possibility of a scenario where "balance sheet reduction precedes rate cuts" which may create continued pressure on assets that are inconsistent with Powell's views, dependent on liquidity, and benefiting from excessive US dollar issuance. The main points of Zhongjin are as follows: The main source of rising inflation in the US is driven by the energy sector. In May, energy prices seasonally increased by 3.9%, with gasoline and fuel prices rising by 7% and 3.8% respectively, while natural gas prices slightly fell by 0.5%. Meanwhile, the secondary transmission effects of rising energy prices are still evident, but not widespread. Airline ticket prices rose by 2.7% month-on-month, and shipping and express service prices surged by 5.2%, both rising for three consecutive months. Food prices rose by 0.2% month-on-month, down from the previous month's 0.5% increase. Looking ahead, the situation in the Middle East has not shown substantial signs of easing, the Strait of Hormuz remains closed, and the high energy prices may persist. Core inflation remained moderate overall, partially due to the high energy prices squeezing consumer demand. The most notable is the automotive sector sensitive to oil prices: new car prices fell by 0.3% month-on-month in May, while used car prices increased slightly by 0.1%, motor vehicle insurance prices fell by 1.7% month-on-month, and car and truck rental prices fell sharply by 4.2%, showing a weak overall trend. In terms of services, rent prices rose by 0.3%, significantly narrowing compared to the 0.6% increase in April. One reason is that the rent in April experienced a one-time surge due to statistical factors. Looking ahead at leading indicators of rent, future rent inflation is likely to remain moderate, making it difficult to be a major driver of inflation. Non-rent core services inflation remains moderate, with healthcare services prices rising by 0.5%, mainly driven by dental services (1.9%); transportation services prices fell by 0.6% month-on-month, as the weakness in motor vehicle insurance and car rental prices overshadowed the continued surge in airline ticket prices. In summary, the current inflationary pressures in the US are mainly structural, and cyclic inflation is not yet prominent. Energy shocks, some service prices, and the mismatch of supply and demand caused by the AI wave are the main variables, but a widespread inflation like that seen in 2021-2022 has not yet emerged. However, attention needs to be paid to the possibility of a rebound in total demand and its impact on inflation. Since the beginning of the year, AI capital expenditure in the US has continued to expand, significantly boosting the business sentiment in upstream industries, while employment trends have improved, strengthening economic resilience. In this context, the resurgence of cyclic inflation cannot be ruled out once businesses' willingness to raise prices and consumers' spending resilience are maintained, making inflation stickier than in the case of just energy shocks. In terms of monetary policy, the benchmark judgment in the mid-term outlook report is that the Federal Reserve will neither cut interest rates nor raise them within the year. As overall inflation has exceeded 4%, double its 2% policy target, it will strengthen the Fed's decision to abandon rate cuts within the year. However, based solely on this inflation report, it will not prompt the Fed to quickly switch to raising interest rates, as inflation pressure is still mainly structural, and core inflation remains moderate, with no signs of overall overheating in the economy. At the same time, it is expected that the Fed's attitude will remain hawkish, and even with Powell in charge, it will be difficult to shift towards a dovish stance. After experiencing the credibility cost of falling behind the curve in 2021 due to underestimating inflation, the Fed is unlikely to easily describe this round of inflation as "temporary" again. With the labor market basically stabilizing, the focus of monetary policy in the second half of the year will return to inflation. The Fed will need more time to observe whether inflation pressure will stop at energy shocks or evolve into demand-driven cyclical inflation further under the influence of AI demand. Faced with high inflation, Powell's primary task after taking office will be to establish policy credibility. It is expected that this will prompt him to make some concerned remarks on inflation to demonstrate his determination to stabilize prices. However, demonstrating determination usually has two paths. One is to suggest that interest rate hikes are not ruled out when necessary. But it is judged that Powell is not inclined towards this, as it contradicts his policy proposal of "balance sheet reduction + rate cuts". The second is to take a hawkish stance on balance sheet policy, strengthening expectations of balance sheet reduction. The latter is more likely, as it also aligns with his consistent monetarist beliefs - inflation is a monetary phenomenon throughout. Therefore, it is not ruled out that a situation of "balance sheet reduction preceding rate cuts" may occur, and this combination will put continued pressure on assets that are purely dependent on liquidity, benefit from excessive US dollar issuance, and are inconsistent with Powell's monetary views. Fundamentally, these assets are incompatible with Powell's monetary beliefs, and this is the main reason for his recent underperformance. It is also reiterated that Powell's assumption of office may be a significant watershed in the Fed's policy framework, marking the end of the era of massive liquidity injection and having far-reaching implications for the macroeconomy and financial markets. Chart 1: The year-on-year increase in CPI in May is the highest since 2023 Data source: Haver, CICC Research Department Chart 2: Gasoline price increases are the main driver Data source: Wind, CICC Research Department Chart 3: The month-on-month growth rate of rent in May fell to 0.3% Note: The housing rental project is the weighted average of the equivalent rent of owners and the main residence rent, calculated as the month-on-month growth rate. Data source: Haver, CICC Research Department Chart 4: The month-on-month increase in non-rent core services fell to 0.3% Data source: Wind, CICC Research Department Chart 5: Overall performance of core goods inflation is moderate Data source: Haver, CICC Research Department Chart 6: Labor market rebound may provide support for demand Data source: Wind, CICC Research Department