The stability of the U.S. economy may be just an illusion January 30, 2007 08:31 China Insurance Regulatory Commission website The Federal Reserve will meet again this week to discuss interest rate decisions, and the market believes that the Federal Reserve will once again maintain interest rate policy unchanged. However, the recent encouraging data may be just an "illusion." The stabilization of the U.S. economy may be due to the expected reduction in interest rates by the Federal Reserve, which reduces the cost of market funds and supports the economy, rather than the current interest rate level being suitable. The data released last week may have surprised many people to discover that the U.S. economy is not as bad as they thought. The US new home sales data in December last year was much higher than expected, and the 4.8% increase was enough to make people believe that the US real estate market has recovered from the recession. With economic data so good, what reason does the Fed have to cut interest rates? However, maybe things are not as rosy as they seem. Interest rate policy is a tool used by the central bank to adjust the cost of funds in the market and thereby regulate the economy. The market reacts very quickly to interest rate policy. Generally speaking, when the market expects an interest rate cut, market interest rates will fall, lowering the cost of funds and supporting the economy. This reaction is particularly obvious in the bond market, so the bond market is often called the "vigilante" of the central bank. This can be seen from the spread relationship between the US dollar 3-month Libor (London Interbank Offered Rate) due in one year and the spot 3-month US dollar Libor. The rise and fall of this spread respectively indicates whether the market is ready to raise or cut interest rates. expectations. In the first three U.S. interest rate cuts in 1985, 1995, and 2001, the spread between the two interest rates began to decline approximately 12 months before each Fed rate cut, and became negative 2 months before the rate cut. It then began to rebound and remained flat about 7 months later. This kind of market reaction has many benefits for the economy, meaning that central bank monetary policy may act better and more smoothly on the market. However, this harmonious relationship is based on the market's full trust in the Federal Reserve. Once this trust relationship is breached, things change. The current trend in the spread between these two interest rates is quite subtle. This spread began to move significantly lower 14 months ago, lasted for exactly 1 year, and became negative about 10 months after it began to decline. Based on experience, the Fed should have cut interest rates two months ago, but this was not the case. Two months ago, this spread began to rebound. Market expectations for an imminent rate cut by the Federal Reserve have begun to weaken, which is consistent with the trend of this spread in recent months. Interest rate futures began to show last weekend that the Federal Reserve may not adjust interest rates or even raise interest rates this year. Trends in the U.S. Treasury market also provide evidence. Since the beginning of December last year, the yield on the 10-year U.S. Treasury bond has increased by about 35 basis points, and the yield curves of other varieties of Treasury bonds have followed similar trends. So, what exactly does the current situation mean for the U.S. economy and the Federal Reserve? We believe that expectations for the Federal Reserve to cut interest rates have had a great impact on market interest rates for a long time in the past, which has reduced market capital costs and provided support to the economy. However, this does not mean that the current interest rate level of the Federal Reserve has an impact on the current The economy is appropriate. For the market, if the Fed's interest rate policy remains unchanged, investors who believe that the Fed will cut interest rates will face losses, and market interest rates will rise back or even exceed current levels, thus hitting economic growth. Therefore, the stabilization of the U.S. economy may be largely due to the fact that expectations of interest rate cuts by the Federal Reserve have led to lower market capital costs and support for the economy, rather than the fact that the current interest rate level is suitable. Some Fed officials may already be aware of this. “In my opinion, if the market continues to discount expectations that the Fed will cut interest rates, the current economic stability may be a mirage.” Fed Vice Chairman Cohen said half a month ago, “We don’t know if the Fed does not meet market expectations. If interest rates are lowered like that, the basis for keeping interest rates unchanged, that is, whether the economic stability can be sustained.

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