Journalists reported that after a rare public disagreement at the Federal Reserve's September meeting, the November meeting is also likely to be challenging. Contradictory signals of inflation exceeding expectations and employment data weaker than anticipated have put the Federal Reserve in a dilemma once again.

On October 10th, Eastern Time, data released by the U.S. Department of Labor showed that the U.S. CPI year-over-year growth rate in September decreased from 2.5% in August to 2.4%, marking a six-month decline and the lowest level since March 2021, with a month-over-month increase of 0.2%, slightly higher than expected. The core CPI in September grew by 3.3% year-over-year, reaching a new high since June, with a month-over-month increase of 0.3%, also slightly exceeding expectations.

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At the same time, the number of unemployment benefit claims has risen significantly. As of the week ending October 5th, the number of initial unemployment benefit claims rose to 258,000, a level not seen since August 2023, significantly higher than the previous week's 225,000 and the market expectation of 230,000. Additionally, as of the week ending September 28th, the number of continued unemployment benefit claims rose to 1.861 million, higher than the market expectation of 1.83 million and the previous week's 1.819 million, indicating an increasing risk in the labor market.

Relative to the higher-than-expected inflation data, the significant increase in initial unemployment benefit claims has received greater attention, leading the market to increase its bets on a 25 basis point rate cut by the Federal Reserve next month.

However, the recent rare public disagreement within the Federal Reserve indicates that officials do not have a unified understanding of the current economic data. To achieve the "dual mission" of fighting inflation and stabilizing employment, there is still a tough battle ahead.

The "last mile" of fighting inflation is fraught with difficulties.

As the Federal Reserve enters a rate-cutting cycle, the September inflation data exceeding expectations highlights the challenges of the "last mile" of fighting inflation, which should not be taken lightly.

Lu Zhe, Chief Economist of Founder Securities and Deputy Director of the Research Institute, analyzed for 21st Century Economic Report journalists that the overall and core CPI in the United States in September were higher than expected on a month-over-month and year-over-year basis. From a breakdown, food price increases pushed up overall inflation, possibly related to hurricanes, while core inflation faced "ebb and flow" increases in various items, with super core inflation (non-residential core service inflation) rebounding for three consecutive months.

The difficulty in the "last mile" of fighting inflation lies in the "stickiness" of core inflation, with several factors keeping overall core inflation stickiness high.

Firstly, there is uncertainty in residential inflation. As a component accounting for 36.4% of the CPI, the significant and unexpected fluctuations in the month-over-month growth rate of residential inflation this year have caused considerable disturbance in the market. The unexpected rebound in the month-over-month growth rate of residential inflation in August and the year-over-year growth rate rebound in September, while the month-over-month decline in residential inflation in September is questionable in terms of sustainability. Secondly, items with high volatility or catch-up increases such as hotel accommodation, air tickets, and car insurance have high volatility and prediction difficulty, and have shown "ebb and flow" increases in recent months, keeping core inflation stickiness. Thirdly, the labor market remains relatively strong, with wage growth remaining high, making wage inflation not significantly improved. In addition, the Federal Reserve's significant rate cut of 50 basis points can also easily lead to a rebound in demand, increasing the risk of secondary inflation.Yang Chang, the chief analyst of the policy team at Zhongtai Securities Research Institute, said to the 21st Century Economic Report that looking forward, the U.S. CPI month-on-month growth rate may still have resilience in the short term. Considering that the CPI base started to weaken in October last year, it is necessary to pay attention to the possibility of a rebound in the year-on-year growth rate in the future.

From the perspective of inflation drivers: First, under the disturbance of geopolitical conflicts, crude oil prices stabilized and rebounded in October, and with the base of energy prices last year, the year-on-year decline in energy CPI will narrow in the short term; Second, the U.S. September ISM non-manufacturing PMI recorded 54.9 (previous 51.5), the non-manufacturing new orders PMI was 59.4 (previous 53.0), and the business activity PMI recorded 59.9 (previous 53.3), showing strong demand in the service industry. Coupled with the rebound in U.S. non-farm wage growth in September, it will support core service inflation.

From the perspective of inflation drag factors: First, leading indicators still point to a downward trend in rent price growth; Second, the September ISM manufacturing PMI continued to be in the contraction range, with the price PMI at 48.3 and the new orders PMI at 46.1, indicating weak manufacturing economic activity, cooling demand, and that commodity inflation may not have much room for a significant rebound.

Employment data occupies the "C position"

Although inflation data supports the Federal Reserve to be more "hawkish," the influence of employment data is even greater, supporting the Federal Reserve to continue to cut interest rates.

Lu Zhe analyzed that the simultaneous release of CPI and initial jobless claims, which were lower than the previous value but higher than expected, once plunged the market trading into chaos, with gold and U.S. Treasury bond rates rising at the same time. Traders' probability of the Federal Reserve cutting interest rates in November first fell to 75%, then rose to 96%, and finally stabilized around 91%. The market currently expects the Federal Reserve to cut interest rates by 1.84 times/46 basis points for the rest of the year and 5.8 times/145 basis points by the end of next year.

On the one hand, the overall inflation in September exceeded expectations but continued the downward trend, and the inflation risk has been greatly alleviated. During the period of inflation decline, the market's concern about inflation exceeding expectations is relatively limited. On the other hand, the Federal Reserve's attention to the dual risks of inflation and employment has obviously shifted towards the downward risk of employment. Therefore, employment data such as non-farm and initial jobless claims have a greater impact on the market. Of course, the initial jobless claims data at the beginning of this week were greatly affected by factors such as hurricanes and strikes, and there is a certain amount of noise.

The focus of the Federal Reserve's monetary policy has temporarily shifted from fighting inflation to stabilizing employment. Yang Chang said that under the current preventive interest rate reduction background, the Federal Reserve's attention to labor market data has increased. Coupled with the market's tendency to overestimate U.S. employment levels during hurricanes, after the release of the initial jobless claims data on October 10, the market's expectation for the Federal Reserve to further cut interest rates in November has increased. However, the pace of interest rate cuts is likely to slow down from 50 basis points to 25 basis points.

Yang Chang analyzed that the Federal Reserve's September interest rate meeting statement proposed "to seek to achieve maximum employment and a 2% inflation rate in the long term," adding the expression of "maximum employment." In fact, before the September interest rate meeting, except for the non-farm data, data such as CPI, PPI, and retail sales did not support the decision to cut interest rates by 50 basis points. The Federal Reserve's final decision to cut interest rates by 50 basis points reflected the importance attached to the condition of the employment market.

The Federal Reserve's interest rate reduction policy can be divided into preventive interest rate reduction and relief interest rate reduction according to its intention. The former occurs when the economy shows signs of slowing down but has not entered a recession, and the latter occurs when the economy has shown signs of recession and thus needs relief. At this stage, the U.S. economy has not shown signs of recession, and the Federal Reserve's overall decision still belongs to the preventive interest rate reduction. The Federal Reserve believes that progress has been made in achieving the inflation target, and the status of the economy in the dual tasks has risen. Starting the interest rate reduction cycle with a "big step" of 50 basis points also reflects the Federal Reserve's determination to use preventive policies to hedge against economic下行 risks."Hawk-dove" Disagreements May Become the Norm

Similar to the disagreements at the September meeting, Federal Reserve officials also have significant differences over the latest economic data.

As a recent representative of the hawkish shift, Atlanta Fed President Bostic explicitly mentioned the possibility of pausing rate cuts in November. He is open to either not cutting rates or only cutting by 25 basis points at the November meeting, depending on how the economic outlook evolves. "If the data suggest that it's appropriate to pause rate cuts, then I can fully accept skipping the next meeting." Echoing this, in the "dot plot" submitted at the September meeting, he only expected an additional 25 basis points of rate cuts within the year.

At the same time, Bostic also emphasized that the magnitude of a single rate cut is not important; what is more important is the overall path of rate cuts and the terminal rate. He believes the neutral rate should be between 3% and 3.5%, and that the Fed will bring rates down to this level next year.

Despite the emergence of a minority voice for "pausing rate cuts," the gradual rate cut faction remains the mainstream, with many officials still supporting a 25 basis point rate cut in November.

New York Fed President Williams stated that, given the better balance of risks to achieving inflation and employment targets, policymakers should bring rates down to a more neutral level "over time." He believes that U.S. inflation is moving towards the 2% target, and while the labor market has cooled somewhat over the past year, it remains robust, which should provide the Fed with room to adjust rates to a level that "neither puts pressure on the economy nor stimulates it."

Echoing this, Chicago Fed President Goolsbee also said that over the next year to a year and a half, the Fed will undertake a series of rate cuts. Currently, inflation is close to the 2% target, and the economy is at full employment. The Fed's goal is to maintain these conditions. However, there may be more meetings like September in the near future, where policymakers assess sometimes contradictory data and then make difficult decisions.

In Lu Zhe's view, the Fed's decision-making still depends on the data, and in the current economic cycle inflection point, the uncertainty and conflict between different data have increased the difficulty of judging the current state of the U.S. economy, leading to divergent views among officials on the economy and rate cut decisions. As more data is released in the future and the economic outlook becomes clearer, the decision on rate cuts can become more unified.

Yang Chang analyzed to reporters that Fed officials themselves have differences in their monetary policy stances, either leaning "hawkish" or "dovish." In the process of preventive rate cuts, since there are no obvious signs of recession, policy decisions are highly dependent on subjective judgments of changes in economic data, so it is inevitable that officials' views will be magnified. This disagreement was already reflected at the Fed's September interest rate meeting, where Fed Governor Michelle Bowman voted against a 50 basis point rate cut, stating a preference for a 25 basis point cut. This was the first time since 2005 that a governor opposed a resolution in a vote, and the meeting minutes showed that other officials also preferred a smaller rate cut.

In the face of continuous disagreements in officials' statements, Yang Chang believes that the Fed may tend to provide more cautious or ambiguous forward guidance, maintaining policy flexibility to respond to economic changes, which may lead to increased uncertainty among market participants about interest rate expectations.How to Balance the "Dual Mandate"?

Achieving a delicate balance between stable employment and fighting inflation is not easy, and how the Federal Reserve balances its "dual mandate" has become a necessary challenge to face.

Lu Zhe analyzed that in the September FOMC meeting statement, the Federal Reserve judged that the dual risks of current employment and inflation have become balanced. Therefore, the focus of policy goals shifted from previously focusing solely on the risk of inflation to simultaneously paying attention to employment and inflation. Under the current thinking of the Federal Reserve, due to the further strengthening of confidence that inflation is close to the 2% target, there is a "preemptive" significant rate cut to achieve a soft landing.

Yang Chang told reporters that the Federal Reserve has repeatedly emphasized that achieving maximum employment and price stability are its "dual mandates," and it will gradually adjust interest rates to a neutral level that can accomplish the "dual mandates." Currently, the CME Group's FedWatch tool shows that, under the base case, the Federal Reserve will cut rates by 25 basis points in both November and December, and then make four 25-basis-point rate cuts next year, bringing rates down to the 3.25% to 3.5% range.

Regrettably, Federal Reserve officials are also not very clear about what the "neutral interest rate" is. In the September dot plot, most members' predictions for the "neutral interest rate" are distributed across a very wide range of 2.4% to 3.8%.

In the special environment after the pandemic, forecasting models have "malfunctioned" one after another. Now, the Federal Reserve can only rely on economic data to "feel its way through the river by touching the stones." Lu Zhe analyzed that the subsequent policy pace depends on the data. After the unexpected September non-farm and CPI data, the market's expectation for a rate cut in November quickly adjusted from 50 basis points to 25 basis points. Under the base case, it is expected that there will be a 25-basis-point rate cut in both November and December, and the pace of rate cuts next year will largely depend on the election results. Under Trump's policy scenario, his more aggressive measures such as internal tax cuts, external expulsion of immigrants, and increased tariffs may exacerbate the tail risk of secondary inflation, affecting the Federal Reserve's room for rate cuts next year. Under Harris's policy scenario, the Federal Reserve's room for rate cuts next year is larger, with another 3 to 5 rate cuts possible.

To balance the "dual mandate," the Federal Reserve will adjust its policies at any time in the future. Yang Chang analyzed to reporters that future uncertainties such as the Middle East geopolitical situation and election results will affect changes in U.S. employment and prices. The deterioration of the Middle East situation will raise commodity prices and increase the risk of inflation recurrence. The U.S. presidential election and different election results in the U.S. Congress will bring differentiated impacts. In this situation, market expectations for monetary policy may still undergo multiple adjustments. However, it is precisely because the Federal Reserve has a larger monetary policy space and the flexibility to adjust policies based on data that the probability of a soft landing for the overall U.S. economy remains high.