CICC: The Federal Reserve has reasons to slow down the balance sheet reduction before the third quarter, and strong consumption adds uncertainty to interest rate cuts

The research report from China International Capital Corporation (CICC) indicates that the basis for determining when the Federal Reserve will decide to slow down its balance sheet reduction is whether reserves are sufficient. Based on our calculations and the Federal Reserve officials' research on appropriate reserve levels, at the current pace of balance sheet reduction, financial liquidity will transition from being excessively abundant to moderately ample (meaning that reserves account for nearly 13%) in the third quarter of 2024, and then potentially enter a state of scarcity with non-linear changes thereafter.

Therefore, there is reason for the Federal Reserve to slow down before the third quarter. This can serve as both precautionary measures and offsetting pressures from long-term bond issuances starting in the first quarter.

Additionally, according to the research report, recent data shows that retail sales in December 2023 in the United States increased by 0.6% compared to previous months, marking the strongest growth rate in three months. Looking ahead, robust consumption will increase resilience in the U.S. economy and reduce recession risks. As recession risks decrease, there will also be less urgency for interest rate cuts by the Federal Reserve. CICC believes that it is unlikely for the Federal Reserve to cut interest rates in March as hoped by markets and expectations of six interest rate cuts throughout this year may be too aggressive.