The Federal Reserve's dot plot for this month has reduced the room for rate cuts to 1 time of 25 basis points (BP) within the year, but the repeated emphasis on "data dependence" after the meeting also retains a significant amount of flexible adjustment space for policy. The current policy is in a somewhat dilemmatic state, but the upward revision of economic forecasts for inflation expectations, the repeated emphasis on inflation risks in the post-meeting Q&A, and the upward shift of the neutral unemployment rate target also point to the fact that current inflation remains a more core decision anchor in the dual targets. The Fed has once again revised the neutral interest rate expectation to 2.8% after March. This further verifies that in the case where both inflation and deficit centers may rise, the neutral interest rate may have significantly moved up. We believe that the expectation for the neutral interest rate within the year may be further revised upwards to above 3%.

Considering political pressure and the trend of inflation, we continue to maintain our previous judgment of one rate cut by the Fed within the year. However, in terms of timing, the first rate cut may be initiated in Q3, and it may not be consecutive in Q4 against the backdrop of a rebound in inflation and the end of the election.

**The Fed's policy is in a dilemma, but inflation remains a relatively important decision-making target.**

In terms of the interest rate range, the Fed took no action this month, and the federal funds target rate continues to stay within the 5.25%-5.5% range. Regarding the policy of reducing the balance sheet, according to the original plan announced at the May interest rate meeting, the balance sheet reduction (Taper) officially started in June. The reduction speed of the Fed's holdings of Treasury bonds was revised down from $60 billion per month to $25 billion; the reduction scale of holdings of Mortgage-Backed Securities (MBS) continues to remain unchanged at $35 billion per month.

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Regarding the guidance for rate cuts, although the dot plot for this month only allows for 1 time of 25BP rate cut within the year, Powell still retained a significant policy flexibility in the post-meeting press Q&A, emphasizing that "the Fed will still rely on data for decision-making at each meeting, and the voting members may adjust their expectations." In terms of decision-making basis, Powell's statement fully reflects the current policy's "dilemma" but inflation may still be a relatively important decision-making target. On the one hand, he pointed out that "the Fed will pay close attention to the risks of economic downturn," and on the other hand, he also emphasized that "the current wage growth is still too high, and there is still insufficient confidence in the decline of inflation," reflecting the dilemma of the current policy. But in the end, he also pointed out that "although high interest rates have imposed a burden on the household sector, inflation has a greater negative impact on the economy in the long run."

Although the dot plot for this month only allows for a 25BP rate cut within the year, Powell's multiple emphasis on "data dependent" in the post-meeting Q&A also diluted the "authority" of the dot plot, and the market still has a relatively optimistic expectation of 2 rate cuts within the year. Especially the equity market performance is relatively optimistic, and the U.S. stock market has been generally fluctuating upwards during the meeting, while the 10-year U.S. Treasury bond rate and the U.S. dollar index have rebounded slightly.

**The dot plot points to a 25BP rate cut within the year; the neutral unemployment rate target and the neutral interest rate are slightly raised.**

In terms of the dot plot, this month's dot plot points to a 25BP rate cut within the year, which is significantly narrower compared to the 75BP rate cut space given in the Q1 dot plot.

In terms of economic forecasts, the expectations for GDP and unemployment rate within the year remain unchanged, but the neutral unemployment rate has been revised upwards from 4.1% to 4.2%. The Fed's expectations for GDP in 2024 remain at 2.1%, and the unemployment rate forecast is 4.0%, both consistent with the previous values. However, it is worth mentioning that this month the Fed has revised the neutral unemployment rate target upwards from 4.1% to 4.2%, which also means that although the unemployment rate has increased recently due to the impact of illegal immigration, it is still difficult to break through the policy target threshold and trigger a rate cut. In terms of inflation, the Fed's forecasts for PCE and core PCE in 2024 are 2.6% and 2.8%, respectively, both slightly revised upwards compared to the previous values. This also indicates that since entering Q2, although inflation has fallen, the speed is still not as fast as the Fed expected previously.

In terms of the neutral interest rate, the Fed has once again revised the neutral interest rate expectation to 2.8% after March. This further verifies that in the case where both inflation and deficit centers may rise, the neutral interest rate may have significantly moved up. We believe that the expectation for the neutral interest rate within the year may be further revised upwards to above 3%.From the perspective of inflation, it is not advisable to be overly optimistic about the unexpected decline in this month's CPI. The room for interest rate cuts within the year is indeed insufficient.

In May, the year-on-year growth rate of the U.S. CPI was 3.3%, lower than market expectations, and has fallen for two consecutive months since March; the month-on-month growth rate was 0%, the lowest since 2024. Among the non-core items, the energy item fell by -2% month-on-month, contributing the most to the downward trend in inflation. In the core CPI:

The housing item still showed strong stickiness this month, with a month-on-month increase of 0.4%, which may gradually decline in Q3 but may rebound in Q4. The core goods item saw a month-on-month growth rate return to 0% this month, and is expected to further turn positive in the restocking cycle. Excluding housing, the core services showed a negative month-on-month increase this month, which is a welcome change, but it is largely due to the decline in car insurance prices and air freight rates, the latter of which is also related to the decline in energy prices to some extent. Considering the structure of this month's CPI and the following factors, we believe it is not advisable to be overly optimistic about the unexpected decline in this month's CPI. Although the rent item in Q3 may lead to a continued decline in CPI, inflationary pressures may return in Q4: First, under the expectation of geopolitical instability, energy prices and related items may still fluctuate significantly; second, the core goods item may turn to a positive month-on-month growth in the restocking cycle; third, excluding housing, the core services may rebound, with the May non-farm wage growth still at a high rate of 0.4% month-on-month, and the decline in sticky items is not a smooth path, and items like air freight that fell sharply month-on-month this month may also rebound with the rise in oil prices; fourth, the rent item may rebound in Q4.

We previously pointed out in our report "Development as a Spear, Safety as a Shield": from the perspective of inflationary pressure, formulas such as the Yellen rule indicate that the Fed indeed does not have a clear basis for interest rate cuts.

Considering the political pressure comprehensively, there is a possibility of an interest rate cut in Q3, but it is not certain for Q4.

From a political perspective, we believe that Q3 has the possibility of a single interest rate cut, and the recent weak manufacturing and inflation data also support this. Considering the political pressure and the trend of inflation, we continue to maintain our previous judgment that the Fed will cut interest rates once within the year, that is, the Fed may start cutting interest rates in Q3, and it is not certain to continue cutting interest rates in Q4 against the backdrop of rebounding inflation and the end of the election.

First, if we consider political factors, Q3 will be the only window for interest rate cuts before the election. Q3 is in the sprint stage of the election, and the September interest rate meeting is the last one before the election (the Q4 interest rate meetings are on November 6-7 and December 17-18, U.S. time), and interest rate cuts can better serve political goals. Second, the inflation center in Q3 is slightly lower than in Q4 (mainly due to the rebound of the housing item in Q4), making interest rate cuts relatively more reasonable. Third, the recent marginal weakening of manufacturing data also provides reasonable support for interest rate cuts. Since entering Q2, the U.S. manufacturing PMI has fallen for two consecutive months to 48.7; mainly due to the high raw material prices and the continued impact of the high-interest-rate environment, which has disturbed the manufacturing cycle that should have continued to repair. The ISM PMI Association revised down the annual capital expenditure forecast for manufacturing enterprises to 1% in the updated semi-annual forecast, a significant revision down from the 11.9% forecast at the end of 2023. However, looking forward, driven by the durable goods replacement cycle, the U.S. economy will still be quite resilient in the second half of the year.

As for the U.S. stock market, we believe that the adjustment space for the valuation of U.S. stocks is limited. It is expected that the U.S. economy will remain resilient in the second half of the year, and the profit side will continue to support U.S. stocks. The biggest risk for U.S. stocks within the year comes from geopolitical disturbances. On the one hand, as the election approaches, the change of the leading candidate may lead to industry style rotation; intensified geopolitical games may affect risk preferences from time to time, and the volatility of U.S. stocks may increase. On the other hand, if the Israel-Palestine conflict escalates beyond expectations and causes oil price fluctuations, it will continue to drive the market to trade in stagflation, and U.S. stocks may face significant downward pressure.

In terms of U.S. Treasuries, we believe that the probability of the 10-year U.S. Treasury rate returning to 5% in the second half of the year is relatively low, and the biggest risk comes from the oil price fluctuations driven by geopolitical risks in the Middle East. Under the baseline scenario, the 10-year U.S. Treasury rate will be in a high overall fluctuation in the second half of 2024, with the center slightly lower, but the overall center will still remain above 4%. In terms of the U.S. dollar, looking at the U.S.'s own fundamentals and policies, it may be in a high overall fluctuation in the second half of the year, with the center slightly lower, and it is expected to be difficult to fall below 100. However, compared with U.S. Treasury rates, the downside risk of the U.S. dollar index is relatively greater, mainly due to the influence of the Bank of Japan. The Bank of Japan may raise interest rates twice more within the year, and the market has already priced this quite fully. If wage growth gradually transmits to the demand side in the second half of the year and drives a comprehensive improvement in domestic demand in Japan; at the same time, the wage expectations for the 2025 Spring Offensive are further revised upwards, the market may further trade the expectations of the Bank of Japan raising interest rates in 2025, and drive the U.S. dollar index down.