United Nations Minsheng Securities: Market's Overly Aggressive Rate Hike Expectations Make Actual Fed Action Difficult

Zhitong Finance APP learned that Guolian Minsheng Securities released a research report stating that current market expectations for the Federal Reserve to raise interest rates within the year are rapidly heating up, but the bank believes the actual probability of rate hikes is low. Although inflation concerns have resurfaced, the U.S. labor market has weakened (with new non-farm payrolls close to 0 and the unemployment rate rising), and the rise in oil prices lacks the key foundation for a sustained transmission to inflation: on the supply side, U.S. energy self-sufficiency is increasing, while on the demand side, the economy is relatively weak, fiscal stimulus is tapering off, and the wage-inflation spiral mechanism has not formed.

The bank pointed out that historical experience shows that the Federal Reserve needs strong employment and stable inflation expectations to initiate rate hikes, and current conditions do not meet this requirement. Raising interest rates will exacerbate the economic “K-shaped” divergence risk, impacting AI investments and middle- and low-income groups, potentially leading the “stagflation” trade towards “recession.”

Guolian Minsheng Securities added that resuming rate hikes this year requires multiple conditions to resonate, including geopolitical conflicts pushing oil prices to persistently high levels, fiscal expansion facilitating demand transmission, and changes in the policy stance of the Federal Reserve leadership, but achieving these is currently quite challenging.

The main points from Guolian Minsheng Securities are as follows:

In just a few weeks, market liquidity expectations for the remainder of this year have made a 180-degree turn. Under the pressure of ongoing tensions in the Persian Gulf and persistently high international oil prices, inflation risks have risen again, while major central banks have generally remained on hold this month, even releasing “hawkish” signals, quickly reversing previous easing expectations. Currently, the risk of a global return to a tightening cycle has significantly increased, and liquidity tightening pressures are becoming more prominent, with major asset classes, except for oil and the U.S. dollar, generally facing severe corrections.

Similarly, the Federal Reserve is no exception; at the beginning of the year, the market widely expected the U.S. to cut rates about twice this year; however, with inflation concerns resurfacing, policy expectations have significantly shifted, and the market has even begun to price in the possibility of resuming rate hikes.

However, market expectations often have a linear extrapolation inertia, with the possibility of subsequent fluctuations. Just like the rapidly warming expectations for rate hikes, if corrections occur later, the reverse correction momentum that the market has brewed may be quite severe.

So, is there a possibility for the Federal Reserve to raise rates again this year? We believe this probability is low. Currently, the threshold for the Federal Reserve to resume rate hikes is high, and under multiple constraints, maintaining interest rates at their current level may be its policy bottom line. In the context of a weak economy and obstacles to the transmission of inflation, continuing to cut rates this year remains a possible scenario. Specifically:

1. Learning from history: How does the Federal Reserve enter a rate hike cycle?

First, reviewing previous rate hike cycles, we can find that, regarding the dual objectives of employment and inflation, the Federal Reserve typically has the following typical characteristics before initiating rate hikes:

1. A sustained recovery in the labor market and economic resilience brought about by tight labor supply and demand often constitute important prerequisites for the Federal Reserve to initiate rate hikes. In the rate hike cycles since 1970, the average of new non-farm employment in the three months before the start of rate hikes in the U.S. has generally remained around 200,000, with the unemployment rate showing an overall downward trend, providing solid fundamental support for the Federal Reserve to initiate monetary tightening.

2. The inflation level is an important consideration for rate hikes, but inflation expectations are equally important, as they directly determine the urgency and intensity of the Federal Reserve’s tightening policy. The Federal Reserve does not always raise rates in response to a noticeable rebound in inflation; even when the economy stabilizes and short-term inflation is mild, the Fed may adopt preemptive rate hikes due to concerns about wage stickiness and subsequent inflation rebounds, making future inflation expectations more important at this time; during the oil crises of 1973, 1977, and the significant supply shocks in 2022, the Federal Reserve often exhibited a lagging response to rate hikes, with the pace of interest rate increases often synchronized with rising prices, sometimes lagging behind higher inflation.

In contrast, the current phase shows obvious differences from historical rate hike cycles:

On one hand, the U.S. labor market is showing a sustained weakening trend, and the foundation for employment recovery is not solid. Currently, the U.S. new non-farm payrolls are hovering around 0, and the unemployment rate is on the rise. Against this backdrop, if the Federal Reserve rashly initiates rate hikes, it would not only fail to provide policy support but may further impact the already fragile labor market, exacerbating downward economic pressure.

On the other hand, although there are short-term inflation concerns, inflation expectations remain relatively stable. We believe the core reason lies in the current rise in international oil prices, which lacks the key foundation for sustained transmission to inflation on both the supply and demand sides. In comparison to the oil crises of the 1970s and the energy price shocks triggered by the Russia-Ukraine conflict in 2022, the reason those shocks were able to continuously spread to inflation fundamentally relied on the special supply structure and strong demand stimulus policies at the time, which are not present in the current situation.

Specifically, the stagflation pattern in the U.S. in the 1970s originated from supply shocks combined with insufficient policy determination, ultimately leading to a decoupling of inflation expectations. In fact, even before the oil crisis, inflation risks in the U.S. had already emerged. Under the Keynesian stimulus framework pursued for a long time after World War II, the government continued to implement expansionary fiscal and monetary policies to maintain high economic growth and full employment: on the one hand, the “Great Society” welfare program significantly expanded fiscal spending, causing the overall deficit rate in the U.S. to rise in the mid-to-late 1960s; on the other hand, the Federal Reserve maintained a long-standing loose liquidity policy, with the money supply growing too rapidly, pushing total demand to overheat continuously, inflating inflation expectations, while the Federal Reserve did not tighten policies in a timely manner to curb this, and subsequently lacked sufficient determination to tighten during the anti-inflation process.

Ultimately, under a series of supply shocks in the 1970s, inflation expectations were completely decoupled. The Middle Eastern wars triggered an OPEC oil embargo, leading to severe shortages of international crude oil. Given that the U.S. was highly dependent on overseas supplies as a net importer of crude oil with weak energy self-sufficiency, the rise in oil prices directly pushed up production costs across the entire U.S. industrial chain, forcing companies to raise prices, which became the core ignition point for overall inflation to rise. Additionally, at that time, U.S. unions were strong, making wages difficult to decrease, further driving up corporate costs and causing prices to continue rising, forming an inflation spiral.

In contrast, the high inflation in the U.S. in 2022 was more a result of overheating demand after the pandemic and a tight labor market resonating together. Of course, the Russia-Ukraine conflict triggered global energy supply disruptions, which were an important external ignition point for this round of inflation; however, the more fundamental driving factor was the massive fiscal and monetary stimulus policies implemented during the pandemic, which provided demand support for cost pressures to continue transmitting downstream. The concentrated release of excess savings by households led to a temporary overheating of consumption demand, combined with high wage growth resulting from a tight labor market (caused by a sharp decline in labor force participation rates due to the pandemic), which rapidly transmitted cost pressures to goods, services, and rent, ultimately giving rise to the broad inflation not seen in nearly forty years.

The trends in inflation structure also confirm this: U.S. energy inflation had quickly peaked and started to fall in 2022, leading to weakness in the commodity sector, but core CPI components such as housing only entered a downward channel by mid-2023, with overheating in service demand under fiscal stimulus being an important reason for the strong persistence of this round of inflation.

Currently, both on the supply side’s ability to withstand shocks and on the demand side’s transmission power, there are fundamental differences from the previous two cycles:

On the supply side, the role of the U.S. in the global energy supply structure has fundamentally weakened the ability of oil prices to transmit inflation. On the one hand, the shale oil revolution has increased U.S. crude oil self-sufficiency and turned the U.S. into a net exporter, significantly enhancing its ability to resist geopolitical supply disruptions, making it difficult to form a sustained energy gap; at the same time, the revenues from crude oil exports can offset rising corporate costs, somewhat suppressing pricing pressures; on the other hand, the rapid promotion of new energy sources and continuous improvement in industrial energy efficiency have reduced the overall dependence of the U.S. economy on crude oil, leading to a decreasing weight of energy in the CPI basket and a weakening impact on overall inflation.

Simultaneously, the absence of a wage-inflation spiral mechanism has also become an important factor in restraining the continued diffusion of inflation on the cost side. Currently, the U.S. labor market continues to cool, job vacancies are gradually converging, and the decreasing power of unions and wage stickiness mean there has not been a significant positive feedback loop between wages and inflation, effectively blocking the possibility of cost pressures spiraling upward and fully driving up prices.

On the demand side, the weak economic pattern makes it difficult to support the smooth transmission of oil price increases downstream. Although the Federal Reserve has begun a rate-cutting cycle, policy interest rates still significantly exceed neutral levels, and the overall monetary environment remains tight, exerting pressure on consumer durable goods spending, investment, and the real estate market. Meanwhile, the U.S. government’s high debt level and significant fiscal constraints have gradually reduced the role of fiscal support for overall demand.

Under the “K-shaped” economic divergence in the U.S., this round of oil price increases lacks broad-based demand support, making it difficult to diffuse into comprehensive and sustained price increases from the energy side (refer to the report “The U.S. Economy: The ‘K-shaped’ Divide Amidst Mixed Conditions”). Especially under high interest rates, core inflation components such as housing are still in a trend of decline, which further weakens the upward momentum of overall inflation and provides key demand-side support for maintaining stable inflation expectations.

Reviewing history, it is also not difficult to see that since the stagflation of the 1970s, the secondary pulling effect of oil price fluctuations on core inflation has significantly weakened. This is attributed to the transformation of the energy structure, strengthening of the Federal Reserve’s discipline, and flexible adjustments in the labor market, especially in the absence of strong support from the demand side, making it harder for oil price shocks to form sustained inflation transmission momentum.

Therefore, in the face of such supply shocks, the Federal Reserve’s traditional policy logic is usually to not consider the short-term inflationary upturn and wait for more substantial inflation transmission, stable core inflation recovery, or significant upward inflation expectations before considering initiating rate hikes. The core of this logic is also to take into account that the sustainability of short-term supply-side transmissions is not clear, and economic slowdowns often provide some hedging against inflation.

Of course, this time is no exception. From the weak performance of the aforementioned labor market to the efficiency of inflation transmission, the U.S. does not have the conditions for raising interest rates this year. Moreover, the short-term geopolitical situation in the Middle East still presents significant uncertainties; the sustainability and trajectory of rising international oil prices are unclear, and coupled with the fluctuating attitude of Trump’s policy level, if the Federal Reserve rashly raises rates, once oil prices fall afterward, the frequent adjustments of Federal Reserve policies are likely to exacerbate market expectation disorders and lead to significant volatility in financial markets, which would be detrimental to the smooth operation of the economy.

2. The Cost of Rate Hikes? From “Stagflation” to “Recession” Trades

In addition to the stringent conditions for rate hikes, the costs of raising rates are also something the U.S. economy and the Trump administration may find difficult to bear. In the context of a weakening U.S. economy and financial markets (except for AI), rushed rate hikes could significantly negatively impact the economy, and the current pricing of the “stagflation” trade may be weak, with a high possibility of evolving into a “recession” trade.

As we previously mentioned, the core issue facing the U.S. economy is the “K-shaped” divergence, which is also the fundamental problem that Trump must solve in this midterm election year. On the one hand, maintaining AI investment’s support for the economy and the stock market’s rise to drive consumption is essential; on the other hand, maintaining the intensity of fiscal expansion to “ensure livelihoods” is crucial. Once interest rates rise, the negative impact on both aspects is evident:

First, regarding AI investment, although the current AI industry is still in the deepening phase of implementation and may not yet have reached the level of forming an asset bubble, concerns about high valuations and rapid increases have emerged multiple times in the market. The overall vulnerability of tech stocks has significantly increased, making them extremely sensitive to changes in policies and liquidity, and any slight “stir” can easily trigger severe fluctuations. Once rate hikes are implemented, it could lead to sustained negative expectations in the market, causing a rapid decline in risk appetite, which would not only trigger valuation corrections in tech stocks (with MAG7 accounting for over 30% of the total market capitalization of the S&P 500) but also directly reduce the wealth effect for households, potentially leading to a cooling of investment and financing in the AI sector and a contraction in capital expenditures.

This logic is not an isolated case; historical experiences from the 2000 dot-com bubble period serve as a significant warning: during periods of tightening liquidity and rising interest rates, high-valuation growth sectors often bear the brunt, as the prior valuation expansions driven by capital become unsustainable. If coupled with profit realizations falling short of expectations, it easily leads to a “Davis double-kill” scenario of valuation and earnings, creating a situation where both capital markets and industrial investment cool down simultaneously. In 2000, as the Federal Reserve raised rates consecutively, valuations of tech giants like Cisco, Microsoft, and Intel rapidly collapsed, and their stock prices plummeted. The market’s narrative of growth for the new economy was quickly revised, capital expenditures shrank significantly, and the decline in risk appetite and slowdowns in industrial investment mutually reinforced each other, forming a significant negative feedback loop.

Similarly, current AI investments are also crucial for the growth of the U.S. economy, becoming an indispensable part. By the fourth quarter of 2025, U.S. AI-related investments are expected to contribute 1.07% (4QMA) to the annualized quarter-on-quarter growth rate of the U.S. economy, accounting for about half of total growth. If rising interest rates lead to a rapid contraction in corporate investments, it could significantly amplify downward economic pressure, becoming an important driver of a recession.

Second, the “dual squeeze” effect from rising interest rates and oil prices will significantly exacerbate the living costs and debt repayment pressures on middle- and low-income groups, potentially triggering deeper livelihood crises. In fact, the current economic situation of the middle- and low-income groups in the U.S. is already more fragile, as revealed in our report “The U.S. Economy: The ‘K-shaped’ Divide Amidst Mixed Conditions.” These groups have clearly fallen behind in economic growth, and livelihood pressures have become the core pain point of the U.S. economy.

Against this backdrop, if rising oil prices resonate with the rate hike cycle, it will undoubtedly be “adding insult to injury.” Rising oil prices directly push up basic living expenses such as transportation and heating, eroding already diminished disposable income; meanwhile, rate hikes mean increased interest expenditures on mortgages, credit card debt, and other debts, further squeezing household financial flexibility. The combination of both may not only force middle- and low-income families to cut necessary consumption and postpone large expenditures but could also push them to the edge of debt default, thus posing substantial threats to their quality of life and balance sheets, which is very unfavorable for Trump in facing the midterm elections.

According to estimates from the Dallas Federal Reserve, the closure of the Strait of Hormuz would significantly impact the economy in the second quarter of 2026, dragging down growth by as much as 2.9 percentage points in a single quarter. Although short-term reopening may allow economic activities to rebound, substantive supply chain shocks have already formed, and the decline in global supply chain efficiency, along with subsequent inventory disruptions, will inevitably drag down the extent and time of economic recovery. If the impact of rate hikes is added at this time, the resonance of supply shocks and tightening financial conditions could plunge the U.S. economy into severe slowdown.

Therefore, whether due to pressures from economic downturns or Trump’s political considerations, the costs and resistance faced by this administration in raising interest rates are undoubtedly significant.

3. Potential “Roadmap” for Resuming Rate Hikes This Year?

So, what conditions might trigger the Federal Reserve to raise rates this year? We believe that if the Federal Reserve is to resume rate hikes this year, it may need to form resonance from multiple aspects, including the sources of inflation, demand transmission, and policy constraints:

On the source of inflation, a long-term stalemate in the Middle East situation may keep oil prices at $100-120 per barrel or even higher throughout the year. According to our previous estimates, under static models, U.S. inflation will rise to over 3.5% this year. More importantly, if geopolitical conflicts continue to escalate and supply disruptions remain unresolved, the sustained rise in energy prices will ignite medium- to long-term inflation expectations, which is more critical for a shift in Federal Reserve policy than a simple rebound in inflation readings.

In terms of transmission mechanisms, Trump may need to implement larger-scale fiscal expansion policies to break through demand bottlenecks. In this midterm election year, if Trump emulates Biden’s approach by introducing large-scale fiscal stimuli, directly boosting disposable income through resident subsidies, tax cuts, and a series of promises for affordability support, it could quickly activate end-demand and potentially open the channel for oil prices to transmit downstream into investment consumption, which may become the biggest risk source for secondary inflation this year.

On the policy constraint front, whether Waller can uphold policy independence is also a key condition that cannot be ignored. Compared to Powell, Waller’s current policy stance is clearly more dovish, publicly leaning towards lowering rates to around 3% in this election cycle, and his determination in policy and anti-inflation measures appears relatively weak. Under pressure from the White House, his likelihood of shifting towards tightening is questionable. In addition, the transition process of Federal Reserve leadership itself also poses potential risks; if Waller fails to pass Senate confirmation smoothly, Powell will continue to lead decisions as acting chairman, potentially increasing the likelihood of resuming rate hikes this year.

Therefore, considering the above three major conditions, we believe that important indicators to observe this year include: marginal changes in inflation expectations (the sustainability of oil prices), the timing and effectiveness of fiscal policy rollouts, and Waller’s subsequent policy statements and decision tendencies. These variables will collectively influence whether the Federal Reserve will shift its policy this year and the pace and magnitude of such a shift.

But at least from the current perspective, considering the challenges in meeting the above conditions, the difficulty and threshold for the Federal Reserve to raise interest rates this year are not low.

Risk Warning: U.S. inflation may exceed expectations with sticky inflation, and tariff transmission may exceed expectations; escalation of geopolitical conflicts and significant increases in oil prices; U.S. fiscal policies may exceed expectations; data calculations may contain deviations.