The Federal Reserve will cut interest rates once in the second quarter, and the impact of slowing QT on US Treasury bonds is limited.

Authors: Guo Jiayi, Zhang Juntao; Source: Industrial Research

On March 20, Beijing time, the Federal Reserve announced the results of the March monetary policy meeting, maintaining the upper limit of the interest rate at 4.5% as expected and slowing down the QT of Treasury bonds, while Waller opposed the tapering. After the announcement, the dollar index narrowed its intraday gains, the 10Y yield on U.S. Treasuries fell, U.S. stocks rose, and gold continued to set new historical highs. The market's expectations for the Federal Reserve to cut interest rates in 2025 remain stable at 2 to 3 times (50 to 75bp ).

The statement from this interest rate meeting has only one noticeable change, removing "the risks of achieving the employment and inflation targets are roughly balanced" and replacing it with "the uncertainty of the economic outlook has increased." Starting in April, the monthly reduction cap for U.S. Treasury bonds has been lowered from $25 billion to $5 billion. The monthly reduction cap for agency bonds and MBS remains unchanged at $35 billion. This quarterly economic forecast has downgraded the economic growth expectations for three consecutive years, raised the unemployment rate expectation for this year by 0.1%, and increased the expectations for PCE and core PCE by 0.2% and 0.3% respectively, to reflect the stagflation risks brought about by tariffs. The dot plot central has not changed, with committee members' expectations centered on interest rate cuts of 1 to 2 times ( 25 to 50bp ), which is relatively close to market expectations.

The Federal Reserve emphasizes the uncertainty of inflation, but shows indifference towards the recent rise in inflation expectations and the decline in some economic data. Considering that the current decision-making style of the Federal Reserve tends to wait for economic data before making judgments, and the inflation data released in April and May is likely to cool down, there is a strong possibility that the market expectations for a rate cut in June will be realized. The risk of inflation rebounding in the second half of the year is significant, and there is considerable uncertainty about whether another rate cut can be implemented after June.

Against the backdrop of the continuous expansion of US debt and the weak demand from overseas investors, merely relying on the Federal Reserve to slow down or stop tapering has limited benefits for US Treasuries. The term premium of US Treasuries remains in an upward channel this year.

Event: The Federal Reserve Remains Steady as Expected

In the early hours of March 20, Beijing time, the Federal Reserve announced the results of the March monetary policy meeting, choosing to remain on hold as expected, keeping the upper limit of the federal funds target rate at 4.5%, slowing the pace of Treasury QT while maintaining the MBS reduction limit. After the announcement of the meeting results, the dollar index narrowed its intraday gains, the 10Y yield on U.S. Treasuries declined, U.S. stocks rose, gold continued to reach new historical highs, and the USDCNH night trading fell below 7.23. On the 20th, the USDCNY midpoint was reported at 7.1754, a decrease of 56 pips from the previous trading day, indicating a devaluation direction of the RMB. The market's expectations for Federal Reserve rate cuts in 2025 remain stable at 2 to 3 times, with each cut expected to be between 50 to 75 basis points.

I. Key Points from the Federal Reserve's Interest Rate Meeting

There was only one significant change in the wording of the statement at this meeting, deleting "the risks of achieving the employment and inflation targets are broadly balanced" and replacing it with "increased uncertainty about the economic outlook". However, at the press conference, Fed Chairman Jerome Powell said that there is no need to read too much into this change. The Federal Reserve announced that starting in April, the limit of the monthly reduction of US Treasury bonds will be lowered from $25 billion to $5 billion. The cap of $35 billion in a single month for agency bonds and MBS remains unchanged ( and the target remains unchanged, and the actual rate of reduction is about $15 billion to )$20 billion per month. Governor Waller voted against it, supporting unchanged interest rates but opposing a slower reduction in balance sheet reduction. The three-year economic growth forecast for this quarter has been revised downward, raising the unemployment rate by 0.1% this year, and raising the PCE and core PCE forecasts by 0.2% and 0.3%, respectively. To some extent, this reflects the recent weakening of some economic data and the short-term impact of Trump's economic policies. There is no change in the center of the dot plot this time, and the expectations of the committee members are concentrated on 1~2 (25~50bp) interest rate cuts, which is close to market expectations.

Main content of the press conference:

Regarding the economic recession: External economists' expectations for a recession in the U.S. are rising, but the absolute level is still not high. Powell believes that a recession is unlikely. Although some survey data indicates that uncertainty and downside risks have significantly increased, hard data remains robust. There is not always a close relationship between survey data and hard data.

Regarding inflation: Higher inflation expectations largely stem from tariffs, which have particularly boosted short-term inflation expectations. Efforts are underway to strip out the non-tariff impact of inflation (nontariff inflation). The target of price stability is becoming increasingly close, but tariffs may slow down this process. When asked if we have returned to the assessment that "inflation is transitory (transitory)," Powell indicated that it is difficult to judge whether it is "transitory" in the face of tariff-induced inflation.

Regarding interest rates: if the economy performs robustly, the Federal Reserve is happy to keep rates higher for longer(. Continue to closely monitor economic data, and the correct approach is to keep waiting until the economic situation becomes clearer.

II. High Probability of Realizing the June Interest Rate Cut Expectation

The inflation uncertainty caused by current tariffs and other policies is a major potential factor restricting the Federal Reserve from further rate cuts. Recent surveys have shown a significant rebound in inflation expectations, which is evident not only in short-term expectations but also in long-term expectations over 5 and 10 years. However, the inflation expectation indicator constructed by the Federal Reserve is quarterly data and has a lag, currently only updated to the fourth quarter of 2024, and the data remains stable. This may also be the reason why Powell has been vague about inflation expectations. The decision-making style of this Federal Reserve tends to wait for economic data before making judgments, rather than adjusting policies ahead of economic data. Considering that the inflation data released in April and May is likely to cool down, there is a high probability that the Federal Reserve will meet the market expectation of a rate cut in June. From our constructed short-cycle indicators, the window for a Federal Reserve rate cut is still open ) indicator reading <1(. The risk of inflation rebounding in the second half of the year is significant, and expectations for rate cuts within the year will still fluctuate, with considerable uncertainty about whether further cuts can be made after June.

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3. The impact of slowing down quantitative tightening on US Treasuries is limited!

In January this year, we pointed out in "Can the Fed End Balance Sheet Reduction Bring Down Term Premiums?--US Treasury Monthly Report 2025, Issue 22", that the Fed is likely to stop shrinking its balance sheet in the first half of this year. In April, the upper limit of the monthly reduction of U.S. Treasury bonds was lowered to $5 billion, and the actual effect is very close to stopping the balance sheet reduction. However, due to the continuous growth of U.S. debt, the proportion of U.S. bonds held by the Fed is still in a downward channel, and the term premium is likely to remain in an upward channel during the year. In addition, after 2020, the market has paid more attention to the U.S. fiscal deficit, and the term premium is highly positively correlated with the U.S. government's leverage ratio. At present, the CBO predicts that the US government's leverage ratio will continue to climb, and also supports the upward trend of term premiums. In summary, the Fed's slowing down or stopping balance sheet reduction has limited actual benefits for U.S. Treasuries.

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