From June thirtieth, two thousand twenty-five to July fourth, two thousand twenty-five

I. Foundation 

resistance to change and hence greater dependability for the results shown in the past.

Expectations first: reviewing the 18-19 rate-cutting cycle

The sustained decline in 2-year Treasury yields, coupled with the upward trend in stock prices,

shows the market is displaying the characteristic of "expectations first,"

The 2018-2019 rate-cutting cycle offers some useful reference:

Chart: 2-year Treasury yields have fallen sharply since 6 20

At the time, the Fed did not begin its first rate cut until 2019 7,

but 2-year Treasury yields had already begun to decline as early as the end of 2018...

Chart: 2018-2019 policy rate and 2-year yield; the 2-year yield began declining ahead of the policy rate.

Although major market indexes fell sharply at the end of 2018,

they then rebounded quickly and remained resilient throughout the whole of 2019.

Chart: SPX price action from 18/10/1 to 19/12/31

2025.07.02

Fed policy framework2.0: Second monetary policy framework review

This article draws on Michael Feroli’s internal report, “US Fed framework: Feels like we only go backwards,” and adapts it with additional context and detail. Michael Feroli is currently J.P. Morgan’s chief U.S. economist; before joining J.P. Morgan at the beginning of 2006, he was an economist on the Federal Reserve Board.

The Federal Reserve is about to complete its second monetary policy framework review. This change is unlikely to have a material impact on interest rate policy in the short or medium term, but over the longer term, we will see a shift in the decision-making model, including a possible move from average inflation targeting (FAIT) back to a traditional simple inflation target, as well as a return to the definition of the employment objective.

The Fed’s first monetary policy framework review took place in 19-20, The central question in that framework review was whether FOMC had raised interest rates too early in 2015; this review arises from the opposite concern: whether rates were raised too late in 2022.

The Fed began raising rates in 2015 12 for the first time since 2006. At the time, core PCE inflation was only 1.3%, and unemployment was 5.1% and continuing to fall. Under the monetary policy practices of the time, raising rates preemptively, before unemployment fell to the estimated “natural rate of unemployment,” was standard practice.

However, that preemptive rate hike ultimately backfired.

Global growth fluctuated sharply, and energy prices plunged. In 2016, U.S. manufacturing entered contraction, and manufacturing employment fell for the first time since the financial crisis. In that year’s election, Michigan, Pennsylvania, and Wisconsin—three states with a relatively large manufacturing presence—shifted to the Republican Party. A margin of just 78,000 votes across the three states determined the entire election result.

In the following years, core PCE inflation exceeded 2% in only a handful of months.

This prompted the Fed to rethink how it set monetary policy, ultimately leading to the 2019-2020 framework review led by then-Vice Chair Clarida.

Following the 19-20 review, the Fed incorporated two main changes into its policy conduct:

1) Introduced flexible average inflation targeting; 2) redefined “maximum employment” as “shortfalls from maximum employment”

Before this, the Fed’s policy framework was primarily reflected in the Statement on Longer-Run Goals and Monetary Policy Strategy, first published in 2012., which FOMC reaffirmed every year, sometimes with minor adjustments. This framework did not stem from any formal review process; it was an empirical distillation of the “best practices” of monetary policy over the preceding decades.

Some key points of the old framework included:

1) Over the long term, inflation is determined by monetary policy.Therefore, the Fed set an inflation target of 2% and sought to minimize deviations from it, with equal concern for outcomes above or below the target;

2) Over the long term, the level of maximum employment is not determined by monetary policy, but depends on a range of nonmonetary factors.The Fed would try to estimate this level of maximum employment and minimize deviations from it;

3) When the two objectives of inflation and employment conflict, the Fed would adopt a balanced approach, pursuing both objectives together by weighing the size of the deviations and the time needed to return to target.

The framework worked well for a considerable time, but after the global financial crisis its suitability began to be questioned: when interest rates are constrained by the zero lower bound, the Fed cannot provide enough monetary stimulus, leading to persistently low inflation. In theory, policy rates have no upper limit, but the binding lower bound means that inflation faces a systemic risk of averaging below 2% over the entire economic cycle, thereby pulling down the anchoring level of inflation expectations.

The new policy framework sought to break this impasse by introducing “flexible average inflation targeting” (FAIT).That is, when inflation is below 2% for a period, the Fed will strive to create conditions for inflation to run moderately above 2% for some uncertain length of time.This “average inflation targeting” is asymmetric: when inflation is above 2%, the Fed is not required to subsequently push inflation below 2%.

In addition, FOMC also redefined its employment objective—not as minimizing “deviations” from maximum employment, but as minimizing “shortfalls” below maximum employment.

The new framework was formally announced in the summer of 2020, but in less than a year the Fed faced an unexpected new challenge: in the summer of 2021, core PCE inflation approached 4% and then climbed further. This raised a natural new question: should the new framework be held responsible for inflation getting out of control?

It is not hindsight to argue that the new framework contributed to post-pandemic inflation; model-based analysis confirms this intuition: both FAIT and an “employment shortfall” orientation lead to higher inflation and inflation expectations.

Even so, there are still two other real “culprits”:

One was beyond the Fed’s control, and the other was the Fed itself. First, regardless of fiscal or monetary policy, nearly all economies experienced similar shocks at the same time that high inflation emerged in the United States. At a policy framework review conference, University of California, Berkeley economist Yuriy Gorodnichenko noted that the only countries to avoid high inflation were those that imposed price controls on food and energy, indicating that post-pandemic inflation had a strong global common component.

But this does not completely absolve the Fed. At the 2020 9 FOMC meeting, the month after the new framework was introduced, the Fed’s forward guidance on “when to start raising rates” effectively constrained its own policy flexibility. Notably, the Fed said it would consider raising rates only after inflation returned to 2% and unemployment fell back to the natural rate estimated by FOMC.

In fact, this was not the first time the Fed had set conditions for raising rates through “thresholds.” As early as 2012, it introduced the “Evans Rule,” which allowed to begin raising rates when inflation exceeded 2.5% or unemployment fell below 6.5%. Compared with the guidance issued in 2020 9, the Evans Rule was clearly much less restrictive:

Chart: The two different policies were based on different constraints

It should be noted that the new framework introduced in 2020 8 did not require the Fed to use such specific guidance in 9. In particular, the framework did not rule out the Fed continuing to set policy in a forward-looking manner.

These two changes (introducing flexible average inflation targeting; redefining “maximum employment” as “shortfalls from maximum employment”) later became the main culprits behind the problem of raising rates too late in 22. They are now also core objectives that may be reversed in this framework review, and the Fed will most likely return to the old framework from before 2020.

If this reversal goes ahead, the Fed will abandon the framework reform adopted in 2020 and return to its previous path. More importantly, an adjustment does not mean a complete abandonment: even under the soon-to-be-adjusted framework, if a so-called zero-interest-rate environment reemerges in the future, the Fed can still use all the tools it has employed over the past five years.

On the other hand, in the study mentioned earlier, Gorodnichenko cited survey data showing that inflation expectations among the general public did not change when shifting from traditional inflation targeting to FAIT. In another paper presented at the framework review conference, Carl Walsh of the University of California, Santa Cruz, argued that FAIT, as a policy design, does not communicate effectively—it neither specifies how much inflation should overshoot or for how long, nor provides clear operational limits. If FAIT is complex and does not improve public expectations, returning to the clearer “inflation targeting” is a rational choice—which is precisely what the Fed did before 2020.

Moreover, on the Fed returning from “minimizing shortfalls” to “minimizing deviations” in its employment objective, Christina Romer and David Romer of the University of California, Berkeley have long argued that:The Fed tends to run into trouble when it tries to push the “labor market into overheating.”Likewise, Fed researcher Michael Kiley also believes that adopting an asymmetric “employment shortfall” orientation may weaken overall economic stability.

At this point, These two policy changes—returning to simple inflation targeting and returning to a “deviation-based” employment objective—will be formally announced at this year’s Jackson Hole symposium, while FOMC’s future adjustments to its policy communication approach may not come until later this year.

Will these two changes have a material impact on the Fed’s monetary policy operations over the coming year?

The short- and medium-term impact will be limited. 1) The likelihood of “inflation undershooting” in the coming months is not high, so FAIT would have no applicable scenario even if it remained in place. 2) Even before the review, the Fed was much less enthusiastic about pushing the labor market into overheating than it was in 2019.Current monetary policy has in effect implicitly returned to a forward-looking framework with clear objectives: achieving an inflation rate of 2% and bringing unemployment close to the natural level in FOMC’s view.

2025.07.04

II. Insights 

Our Viewpoints and ideas on market...

Oil trading returns to fundamentals (with expected trading range)

The geopolitical risk premium in oil prices has fallen sharply from highs of more than 15 dollars per barrel and now stands at only a few dollars. Oil prices have essentially returned to pre-escalation levels, and the implied risk reflected in options pricing has also declined significantly:Take the Strait of Hormuz: the options-implied probability of a large-scale supply disruption has fallen from a peak of around 15% to a very low level, nearly in line with the beginning of 6.

The sharp decline in the risk premium in oil prices reflects several core market consensuses:

1) Several major geopolitical shocks in recent years have not caused actual disruptions to oil and gas supplies, and the market has grown accustomed to this. This is also why we previously judged that “the price action is more likely to replicate last October”;

2) The relatively muted response of other trading partners indicates that the United States and Qatar had received advance warning;

3) Both China and the United States have a strong desire to avoid a large-scale supply disruption;

4) Trump is highly attentive to energy affordability and will not let prices soar unchecked;

5) Many investors are reluctant to actively bet on a sharp rise in oil prices, and generally believe the oil market will see a clear surplus in the autumn;

Regarding the supply surplus, we have discussed oil fundamentals many times before on Planet, and this was also the basis for our previous short position (see Notes250523Reasons to Short Oil + Notes250527Reasons to Short Oil (continued)),This part is “basically unchanged” apart from geopolitical shocks: 1) OPEC+ ample supply; 2) weak demand growth; 3) inventories have risen for several consecutive months, and currently appear likely to keep growing over the next 18 months.

The focus of the bulls is on declining U.S. inventories but global data show that global crude inventories actually increased by around 130 ten thousand barrels per day over the past 90 days. In particular, There has been substantial inventory accumulation in emerging markets such as Asia, possibly as precautionary stockpiling against geopolitical uncertainty.

All of this data further supports our view that the oil market is oversupplied and prices will fall.

The chart below shows inventory changes since the beginning of the year:

Chart: Oil inventories have risen for several months and will remain significantly oversupplied in the autumn

Oil-producing countries are now focused on capturing as much market share as possible...

Based on current estimates from various institutions, the oil market will see a large supply surplus this year, with annual supply growth close to 4 times global demand growth. This includes strong production growth in non-OPEC countries such as Brazil and Guyana, as well as an expected additional 100 ten thousand barrels per day of supply from OPEC+ countries between 7 and 8 (equivalent to 1% of the global market).

However, Structurally, before the downside trade returns to fundamentals, it is more likely that a calmer environment with falling volatility levels will emerge first，The situation in the Middle East is easing, and summer demand is entering a transition phase, but after the conflict alert has been lifted, the market is bound to price sudden events more cautiously, which also means it will continue to demand a higher geopolitical risk premium for some time(At present, 15-day call skew remains near its highest level in the past three years, indicating that some risk premium has yet to be fully absorbed.)

Chart: Prices may form a range at 55-65, with the upper boundary a potentially viable level for shorting

At this point, At this point, the more likely scenario is for a trading range to form at 55-65 in the second half of the year, with the upper boundary a potentially viable level for shorting.

For a further actual decline, absent another event shock, we will have to wait until the end of the year.

We will update this as developments occur.

2025.07.01

Adding a chart:

2025.07.02

Pricing logic in the U.S. (European) equity market

The chart below shows The co-movement between the Cyclicals vs Defensives Pair and the 1y1ySOFR rate:

The spread between the baskets clearly reveals the pricing logic of the current U.S. equity market (and, in fact, it is not just the U.S. market; European markets are pricing in the same thing)—The market expects the Fed to begin cutting rates against a backdrop of still-adequate growth, and bets on the benefits of those cuts are concentrated in cyclical sectors.

A similar situation occurred in last summer, At the time, subsequent weak economic data shook market confidence in growth, causing cyclical stocks’ outperformance versus defensives, after their early run-up, to be sharply repriced lower.

Chart: Horizon Global Strategy economic calendar

With the nonfarm payrolls report due soon, if it is followed by a strong CPI reading, that could again catalyze a market shift from the “Goldilocks” narrative toward slower growth and a slower-moving Fed.

2025.07.02

III. Market Pulse 

Our latest Comments on the economic and market environment

Another position for USD shorts

As The market has priced in about 2.5 rate cuts by the Fed this year, leaving some room for pricing in the most aggressive scenario of 3 cuts for the full year., but Short positioning is relatively crowded in the near term,

This is also why we did not set our initial EUR/USD target too far out:

Chart: Near the initial target

If the dollar rebounds in the short term after reaching the target, it may first return to around the 55-day moving average. If the thesis remains unchanged, that would be an ideal level to consider shorting the dollar again.

Chart: The 55-day chart shows a possible rebound level

On the other hand, it is important to note that For EUR/USD, once it breaks through cleanly again,

On its way to the 21 high (1.235)there will be no resistance areas left:

Chart: No barriers remain before the 21 high

2025.06.30

Another position for USD shorts (continued)

EUR/USD has reached the target price mentioned earlier, and the market also encountered clear resistance upon reaching 1.18:

Chart: Microstructure

Meanwhile, The Dollar Index also rebounded toward the 55 daily moving average as expected:

Chart: Retracement status

2025.07.02

June Nonfarm Payrolls & Another Position for USD Shorts (Second Continuation) June nonfarm employment data came in far above market expectations (in line with our expectations; see our earlier series of discussions on the unemployment rate on Planet, which is also why we tracked USD positioning daily this week). With support from government-sector employment and a decline in labor force participation, the unemployment rate returned to:

June nonfarm payroll data greatly exceeded market expectations(As we expected; see our previous series of discussions on the platform about the unemployment rate. This is also why we have been tracking dollar positioning daily throughout the week.), with the unemployment rate returning to 4.1% amid support from government employment and a decline in labor force participation:

Dollar surge:

Chart: The surge pushed it back above the 55-day moving average, as we had anticipated

EUR/USD pricing also declined as expected:

Chart: After the data shock, the market plunged straight down beyond our target

2025.07.03

Note: All content herein is for reference only, does not constitute investment advice, and is not a basis for any laws, regulations, or regulatory policies. Investors should not use or rely on this information as a basis for decisions.