Fed: Pause to cut interest rates

# Chuan Yue Global Macroeconomics

Lin Yan of Guolian Minsheng Macroeconomics believes that the pause in interest rate cuts in January is underpinned by two factors: the Federal Reserve's prudent assessment of economic fundamentals and the escalating current political game. Both the meeting statement and post-meeting remarks reflect a shift in the Fed's views on economic and employment risks. Coupled with its firm stance on safeguarding the Fed's independence, the necessity of another rate cut in the short term has declined significantly.

Amid mounting political pressure from the White House, the January FOMC meeting was no longer a simple game over interest rate decisions, but rather a major test of policy resolve intertwined with economic data and political confrontations. Given that market expectations for keeping interest rates unchanged were nearly fully priced in, the suspense of this meeting was never about whether to cut rates, but about how the Fed could hold the line on policy independence amid the squeeze between White House pressure and data constraints. Although Powell did not provide clear guidance on future rate cuts, both the meeting statement and his post-meeting remarks indicated a revised view of economic and employment risks. Together with the Fed's unwavering stance on upholding its independence, the case for an immediate short-term rate cut has weakened markedly.

In terms of asset reactions, the meeting lacked any surprises and did not deviate significantly from market expectations, thus failing to alter the short-term performance logic of major assets. While the U.S. dollar and Treasury yields rose briefly, they both pulled back quickly thereafter. Meanwhile, precious metals such as gold and silver accelerated their gains once more, with gold briefly breaking above $5,400 an ounce.

### Key Focuses of the Meeting

Against the backdrop of sufficient data verification, the pause in rate cuts in January was almost a foregone conclusion. The meeting statement was slightly hawkish overall: its assessment of economic activity shifted from "expanding at a moderate pace" to "expanding at a steady pace", and it removed the reference to "rising downside risks to employment", replacing it with "the unemployment rate has shown some signs of stabilization". This also reflects that after a cumulative 75 basis points of rate cuts, the Fed's policy stance has neared the neutral range, raising the bar for rate cuts in the short term and eliminating the need for hasty easing measures.

Notably, in addition to the widely expected dissenting vote for a rate cut from Milan, Waller also supported further monetary easing. This may involve certain political considerations, or even be seen as a last-minute push for the Fed Chair position.

In the post-meeting press conference, Powell maintained the policy guidance of "prudent wait-and-see and hard data constraints", and refrained from sending signals of a potential rate cut in March. However, his remarks revealed a shift in views on risk balance, acknowledging that "both upside risks to inflation and downside risks to employment may have diminished" and that "the impact of tariffs on commodity prices will gradually peak and then start to decline". These comments all signify that the necessity of a short-term rate cut has dropped noticeably.

In response to the political pressure that has drawn significant market attention recently, Powell offered no substantive replies. On issues such as the Cook case and the Department of Justice subpoena, he consistently adhered to a "no comment" principle to mitigate the interference of White House political pressure on the policy path. He also emphasized the hope that the next Fed Chair would "stay away from politics", thereby consolidating market expectations for policy stability and preventing excessive build-up and spread of easing expectations.

Regarding the balance sheet, although the meeting did not mention it directly, the Fed is expected to largely maintain the pace of the RMP announced in December, providing some liquidity support during the rate cut pause. Since the Fed launched technical balance sheet expansion in December, money market funding rates have edged lower. While the scale of reserves in the banking system has recovered somewhat, it remains at a low level overall, and market demand for further liquidity injection remains strong. Combined with the Fed's earlier statement that it would purchase $40 billion in bonds in the first month and may maintain a relatively high scale of operations in the coming months, we expect the Fed to continue this bond purchase scale in January to sustain liquidity injection.

### Fundamental Drivers of the January Rate Cut Pause

Essentially, the pause in interest rate cuts in January is supported by two core factors: the Federal Reserve's prudent judgment of economic fundamentals and the intensifying political game.

From the perspective of economic fundamentals, the delicate balance between labor market resilience and inflation expectations forms the core economic rationale for the rate cut pause. The labor market exhibits the characteristic of being "weak but not collapsing": the rise in the unemployment rate is limited, and employment growth has slowed but not shown signs of accelerating deterioration. While core CPI has fallen to 2.6%, it remains above the 2% policy target, with sticky prices in service sectors such as housing and healthcare. Furthermore, the pass-through of tariffs to commodity prices remains a latent concern for the Fed. Therefore, waiting for further confirmation of the inflation slowdown trend is undoubtedly a more rational policy choice.

However, economic factors are no longer the sole barriers to rate cuts; the political shocks to central bank independence have become the focus of market attention. Unlike its previous low-key responses, after receiving a subpoena from the Department of Justice over cost overruns at the Fed building and threats of criminal prosecution, Powell made a rare public accusation that the move is essentially a political pretext, directly confronting the White House's pressure for rate cuts. This indicates that the confrontation between Powell and the White House has now become intense.

With the midterm elections approaching, the White House's subsequent pressure on Fed policy is likely to intensify further. Therefore, under the current circumstances, pausing rate cuts may become a necessary measure for the Fed to "defend the line of independence"; otherwise, the subsequent pressure will be even more difficult to handle, and the government's considerations will align with the economic decision-making logic.

### Outlook for Future Interest Rate Rhythm and Rate Cut Expectations

How to judge the future interest rate trajectory and rate cut expectations? We believe that if economic data do not experience unexpected fluctuations and instead continue the moderate trend since December, the necessity of a short-term rate cut will continue to decline, and the Fed will most likely maintain the decision to pause rate cuts until Powell's term ends. As the new Chair takes office after May, coupled with the progress of the midterm elections, the Fed may restart the rate cut cycle. In the baseline scenario, we expect there to still be room for 1-2 rate cuts within the year.

The upcoming announcement of the Fed Chair nomination is likely to become an important indicator affecting market rate cut expectations and capital flows in the short term. Current market prediction data shows that the probability of Rick Rieder taking over as Fed Chair has risen sharply, followed closely by Kevin Warsh, while the probability of Hassett, who was widely regarded by the market as a potential successor, has declined significantly.

From the perspective of policy inclination: if Rieder and Warsh are elected as expected, the Fed will most likely maintain a gradual regulatory approach with a relatively moderate policy stance, and the pace of rate cuts will be more aligned with economic data performance. If Hassett is elected unexpectedly, his previously dovish policy propositions may push the Fed to accelerate the easing process, thereby reversing market expectations for the rate cut cycle and triggering phased fluctuations in the prices of major asset classes.

**Source**: Chuan Yue Global Macroeconomics

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