Guotai Haitong: The reform of the monetary policy mechanism in Washington shows determination to control inflation and is expected to meet the demand for interest rate cuts.

Guotai Haitong released a research report stating that Powell's "practical monetarism" not only demonstrates the Federal Reserve's determination to control inflation to the market, but also can meet Trump's demand for interest rate cuts. The purpose is to correct the market distortions caused by excessive QE and achieve the convergence of the "K-shaped" economy. The main points of Guotai Haitong are as follows: 1) "Balance Sheet Reduction + Interest Rate Cuts": Policy Advocacy of the New Chairman of the Federal Reserve Powell's most prominent policy advocacy is "interest rate cuts + balance sheet reduction". He believes that the Federal Reserve needs to be responsible for inflation, and continuous QE after the crisis is the main cause of inflation, so it is necessary to control inflation through QT. Once inflation risks and policy distortions are corrected, space can be created for interest rate cuts, which Powell refers to as "practical monetarism". Behind the above policy advocacy is a mechanism reform of monetary policy. Powell has criticized the Federal Reserve's huge balance sheet many times, believing that QE distorts market incentives. In 2008, after the financial crisis, the Federal Reserve shifted to the "abundant reserve mechanism" and released a large amount of excess reserves to banks, then controlled the interest rate corridor by paying interest on reserves, allowing banks to "lie flat and earn interest", leading to a decrease in their willingness to lend to the real economy and a shift of funds from real to virtual. Powell advocates reducing the size of reserves through balance sheet reduction, increasing banks' willingness to lend, reversing the abundant reserve mechanism of the crisis era, and transitioning to the "scarce reserve mechanism" before the crisis. 2) Balance between the White House and Wall Street: Why Trump chose Powell Trump's criticism of the current chairman Powell as "Mr. Too Late" made the loyal Hassett the most popular candidate for a while, but his radical interest rate cut advocacy also raised concerns about the independence of monetary policy. Powell, as the most respected candidate on Wall Street, can achieve a better balance between maintaining the independence of the Federal Reserve and expressing sincerity to Trump. "Practical monetarism" not only demonstrates the determination to control inflation, but also can meet Trump's demand for interest rate cuts. QT can be understood as "responsible balance sheet management", focusing on correcting the "infinite bottoming out" mindset of monetary policy on the demand side; interest rate cuts, in coordination with fiscal policy, focus on enhancing supply capacity from the perspective of industrial policy. The essence of this set of policy ideas is to avoid excessive funding "shifting from real to virtual" and to channel low-cost funding to real sectors. This coincides with Trump and Bessonet's supply-side reform ideas. 3) Practical monetarism: Speculation on Powell's Governance Thinking Based on the quantity theory of money, QT is indeed a tool to control inflation. One piece of evidence is that after the Federal Reserve announced the commencement of passive balance sheet reduction in 2022, the CPI quickly dropped from 9% to around 3%. However, the use of QT also has its limits. Recently, due to the liquidity tension in the repurchase market, bank reserves are approaching the "adequate level" recognized by the Federal Reserve, and they had to stop QT and initiate RMP (reserve management purchases). Operationally, a series of deregulation measures for banks (such as relaxing capital constraints) and optimizing the Fed's temporary discount tools for banks could give more space for QT. However, the transition to the "scarce reserve mechanism" is difficult and long. In the short term, liquidity issues will still be a tight constraint on the implementation of QT until bank reserves return to a relatively sufficient level. In addition, the Trump administration's policies such as manufacturing reshoring and thawing of the real estate industry require bank credit expansion, which is inseparable from an adequate level of reserves. The policy orientation of returning from Wall Street to Main Street is conducive to the convergence of the "K-shaped" differentiation in the US economy, but in the conflict between managing the upper (US stocks) and lower ends (inflation) of the "K-shaped" economy, Powell needs a stronger balancing act. Risk Warning: Large fluctuations in US stocks damage consumer confidence, and the repair of the US real economy may be slower than expected.