Author: Zhou, ChainCatcher

After nine months, the Federal Reserve has once again pressed the interest rate cut button.

In the early hours of September 18, Beijing time, the FOMC lowered the target range for the federal funds rate from 4.25%--4.50% by 25bp to 4.00%--4.25%, marking the first interest rate cut of 2025.

The latest dot plot shows that officials predict a median of another 50bp cut within the year. If the next two meetings each cut by 25bp, the federal funds rate may end the year in the range of 3.50%--3.75%.

Powell emphasized at the press conference that this action is a risk management-style rate cut, aimed at reducing the probability of errors in a complex environment with dual risks; the 50bp cut did not receive broad support, and rapid actions will not be taken.

He added that the high inflation since April has shown signs of easing, related to the cooling labor market and the slowdown in GDP growth. Recent inflation increases are more influenced by factors such as tariffs, resembling a one-time shock, and are not sufficient to constitute evidence of persistent inflation.

In the market, the dollar gained support, while gold faced short-term pressure; Wall Street growth stocks saw profit-taking after a prior surge, with the "seven giants" basket of stocks declining, and the style briefly shifted to lower-valued sectors; the overall response of crypto assets was also relatively muted.

How do institutions interpret this rate cut?

From domestic brokerages, Zheshang Securities believes that although the dot plot still leaves room, there is a possibility of a reversal in easing expectations, mainly depending on the impact of the core momentum of the U.S. economy and the stability of the unemployment rate.

CICC mentioned that the threshold for rate cuts will become increasingly high, with the coexistence of weak employment data and rising inflation limiting the space for easing; the current issue in the U.S. is rising costs, and excessive easing may exacerbate inflation, leading to "stagflation." Minsheng Macro stated that the rate cut is the beginning of the problem, and a larger cut may trigger inflation risks, while insufficient cuts may bring political risks.

Overseas institutions also have differing voices. "Fed mouthpiece" Nick Timiraos stated that this is the third time under Powell's leadership that the Fed has begun to cut rates without a clear economic downturn. However, considering the more challenging inflation situation and political factors (the White House's confrontational stance), the stakes in 2019 and 2024 differ from now.

Olu Sonola, head of U.S. economic research at Fitch, stated that the Fed is now fully supporting the labor market, clearly signaling that 2025 will enter a decisive and aggressive rate-cutting cycle. The message is very clear: growth and employment are the top priorities, even if it means tolerating higher inflation in the short term.

Jean Boivin, head of investment research at BlackRock, indicated that the Fed's rate-cutting outlook will likely depend on whether the labor market remains sufficiently weak. He pointed out that Powell stated the latest rate cut was due to increasing signs of weakness in the job market as "risk management," which may mean that future policy actions will heavily rely on data performance. Boivin believes that further weakness in the labor market will provide grounds for more rate cuts from the Fed.

Barclays economists noted that the risks to the Fed's rate path are leaning towards delaying rate cuts. They stated in a research report that if inflation data continues to show strong price increases in early 2026, or if tariff policies push prices up in non-commodity sectors against a backdrop of a moderate rise in unemployment, this situation may arise. Conversely, if the unemployment rate suddenly spikes, the FOMC may take more aggressive rate-cutting measures. Barclays expects that in 2026, the FOMC will keep rates unchanged until signs of monthly inflation data slowing appear and it is confident that inflation is returning to the 2% target trajectory.

Hu Yifan, investment director for Greater China and head of macroeconomic research for Asia-Pacific at UBS Wealth Management, stated that looking ahead, under the baseline scenario, the Fed is expected to further cut rates by 75 basis points by the first quarter of 2026. It is anticipated that the Fed will continue to prioritize the weakness in the labor market rather than the temporary rise in inflation. In a downside scenario, if the weakness in the labor market proves to be more severe or persistent, the Fed may cut rates by 200-300 basis points, with rates potentially falling to 1-1.5%.

How do institutions view the financial markets?

In early trading on September 18, gold futures fell by as much as 1.1%; the dollar weakened initially after the decision was announced but quickly reversed and rose. Soojin Kim, an analyst at Mitsubishi UFJ Financial Group, stated that investors believe the Fed's guidance is less dovish than expected, as Chairman Powell emphasized the inflation risks driven by tariffs and indicated that further rate cuts would be pursued through a "meeting-by-meeting decision" approach, which boosted the dollar.

Francesco Pesole from ING, however, stated that the Fed's rate decision on Wednesday is overall bearish for the dollar, as he believes the decrease in dollar financing costs will further drive the dollar's depreciation. Additionally, the euro against the dollar (EUR/USD) retreated from a four-year high set on Wednesday. Pesole also noted that the euro may regain upward momentum, as ING continues to maintain its target of 1.2 for EUR/USD in the fourth quarter.

George Goncalves, head of U.S. macro strategy at Mitsubishi UFJ, stated that the Fed's decision is the most dovish statement yet, adding another rate cut to the dot plot expectations. He pointed out that the Fed has not entered a rate-cutting sprint mode but is restarting the rate-cutting process due to the labor market's performance falling short of expectations. This is also the reason for the muted response of risk assets. The Fed may cut by 25 basis points in both October and December, and a 50 basis point cut may not necessarily be favorable for credit.

Kerry Craig, a strategist at JPMorgan Asset Management, stated that the U.S. rate cut may support emerging market assets and noted that the 25 basis point cut from the Fed aligns with market expectations. He believes that the rate cut implies a potential weakening of the dollar, which is expected to boost the performance of stocks and local currency debt in emerging market assets. Furthermore, the reduced risk of a U.S. economic recession also means that the credit market will continue to receive good support.

Richard Flax, chief investment officer at European digital wealth management firm Moneyfarm, stated that the Fed's rate cut may boost short-term market sentiment for risk assets, with the stock market expected to benefit. He pointed out that for U.S. households and businesses, this rate cut can provide moderate relief, but the broader policy signal is to remain cautious rather than shift to rapid easing.

Jack McIntyre, a portfolio manager at Franklin Templeton, stated that there are significant divergences in the Fed's policy outlook for 2026, which may mean more volatility in financial markets next year. He noted that this rate cut is a risk management operation, indicating that the Fed is paying more attention to the weakness in the labor market. Investment strategist Larry Hatheway believes that although the market has digested expectations of significant easing from the Fed, the challenge for investors is that the Fed is not yet willing to acknowledge the future low interest rate path anticipated by the market.

Bank of Japan holds rates steady for the fifth consecutive time

On September 19, the Bank of Japan's monetary policy meeting resulted in a 7 to 2 vote to keep the policy rate unchanged at 0.50%, marking the fifth consecutive decision to stand pat.

Among them, two committee members (Takeda Hajime and Tamura Naoki) advocated raising the short-term rate by 25bp to 0.75%, citing increased risks of price increases and the need to bring rates closer to neutral levels. Meanwhile, the Bank of Japan disclosed plans to reduce its ETF holdings, planning to sell approximately 330 billion yen worth of ETFs annually to further advance the policy normalization framework.

The backdrop of prices and growth provided the basis for this rate stability. Japan's core inflation in August was 2.7% (excluding fresh food), the lowest since November 2024, and has fallen for three consecutive months, with overall inflation also dropping to 2.7%.

The market's immediate reaction was somewhat "hawkish but stable." The dollar against the yen briefly dipped to around 147 after the announcement, then fluctuated; the Nikkei 225 index fell by as much as -1.8%, dropping below 45,000 points, while the TOPIX index fell about 1% to 3126.14. On the bond side, Japan's benchmark 10-year government bond yield rose about 3.5bp to 1.63% after the central bank mentioned the reduction of ETF holdings, while government bond futures fell by as much as 53 points to 136.03.

Interpretations from institutions and traders are divided into two camps. Hiroaki Amemiya, investment director at Capital Group, stated that the Bank of Japan's decision to keep rates unchanged highlights its cautious stance amid slowing inflation and global uncertainties—prioritizing stability rather than tightening too early. By retaining policy flexibility, the Bank of Japan signals that it is ready to respond to external fluctuations while continuing to assess the strength of Japan's economic recovery. The current strategy is more about supporting the early stages of a re-inflation cycle rather than reversing direction.

Hirofumi Suzuki, an analyst at Sumitomo Mitsui Banking Corporation, expressed that this outcome was unexpected. Although the market generally anticipated the Bank of Japan to simply maintain its stance, the initiation of the ETF sale plan, coupled with two committee members voting against maintaining the policy (i.e., supporting a 25bp rate hike), gave the meeting a hawkish tilt. From a timeline perspective, even with events such as the October 4th Liberal Democratic Party leadership election, the Bank of Japan still signals a steady advance towards policy normalization. A rate hike may be expected in October.

Additionally, Chris Weston from Pepperstone noted that Prime Minister Ishiba Shigeru's departure shifts focus to his successor and what this may mean for political stability. The market will weigh the extent of additional fiscal measures and budgets under the new leadership, as the degree of fiscal stimulus is crucial for controlling the rise of long-term Japanese government bonds.

He stated that these developments may be seen as another reason to push the Bank of Japan's next 25bp rate hike to 2026. This expectation has already been reflected in the market, with swap traders anticipating only a 12bp hike by December, which Weston pointed out is another reason few are willing to hold the yen. He expects the yen's weakness in the Asian market to become widespread.

Market analysis indicates that the debate surrounding the vaguely defined indicator of potential inflation is heating up, with some committee members advocating for a downplaying of this expression and a greater focus on overall inflation and wages, paving the way for another rate hike as early as October. DBS's economic team predicts that Japan's GDP growth rate in the second quarter may hover around 0%. They forecast that the seasonally adjusted annualized growth rate will rise moderately by 0.2%, just enough to offset the contraction in the first quarter. The momentum of exports in the second quarter weakened, affected by a decline in exports to the U.S. and weak overseas demand.

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