On July 25, a dramatic shift occurred in the U.S. stock market, with major indices plunging steeply, leading to a staggering loss of $550 billion among the tech giants known as the "Magnificent Seven." This event marked a significant moment, breaking a 356-day streak without a decline of 2% or more in the S&P 500 index, which fell by 2.3%. Meanwhile, the Dow Jones Industrial Average lost 504 points, equivalent to a 1.2% drop, and the Nasdaq Composite Index experienced an unprecedented decline of 3.6%, the most significant single-day drop since October 2022.

In the wake of this market turmoil, two speculations surfaced among analysts and economists. The first suggests that the Federal Reserve may decide to omit references to "elevated inflation" in its upcoming monetary policy meetings. The second theory posits that the current and former officials of the Federal Reserve have adopted a more dovish stance, clamoring for interest rate cuts.

The phrase "elevated inflation" first emerged in September 2021, after the inflation rate had consistently exceeded the Fed's 2% target for three months. Today, however, with the Personal Consumption Expenditures (PCE) price index falling to 2.6% in May, the continued use of this terminology seems increasingly inappropriate.

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Market sentiment appears to indicate that the Federal Reserve may alter its course in the near future, interpreting the removal of the term "elevated" from its inflation characterization as a clear signal for looser monetary policy. This change could suggest that a rate cut is on the horizon for September, prompting a reversal in the flow of dollars.

Furthermore, Richard Clarida, former Vice Chair of the Federal Reserve from 2018 to 2022, speculated that as inflation subsides and the labor market cools, the Fed might reduce interest rates twice this year, possibly even three times. Adding to this sentiment, former Kansas City Fed President Esther George noted that the Fed is now perceiving signals conducive to rate cuts.

The anticipation of this monetary shift raises an intriguing question: Will the era of the "dollar hot flow" make a return? What drives individuals like Dudley to insist on immediate rate cuts, arguing that even a month is too long to wait? Is the urgent need for these cuts somehow connected to the recent plummet in U.S. stocks and the widespread lament in global markets?

Looking ahead to 2024, it may be poised to kick off this so-called "dollar hot flow." The question remains, however, whether the Fed's exit from quantitative tightening will happen sooner than expected and if the rate cuts will fall below current projections. There is significant debate about whether this renewed dollar circulation will quickly intensify or develop gradually over time.

The Federal Reserve had announced on May 1 that it would slow down the reduction of its balance sheet starting in June. The Federal Open Market Committee (FOMC) reduced the monthly limit on U.S. Treasury bond sales from $60 billion to $25 billion, aligning with certain forecasts. Nonetheless, despite the expectations of rate cuts in 2024 weakening over time, approximately half of the world's major economies—evidently including Germany, France, Italy, and Canada—had already begun lowering interest rates.

While the Federal Reserve has yet to initiate the dollar hot flow, a reversal is occurring globally, with overseas dollars beginning to follow the interest rate movements of various central banks, gradually warming up before the Fed. The landscape shifted in July, coinciding with the mid-year analysis meetings that arrive at a critical point in time. Why does the Fed feel compelled to lower rates at this juncture?

Superficially, the Federal Reserve's rationale centers on reports of a strong job market and seemingly improving inflation data, signaling an increasingly favorable environment for interest rate reductions. However, such signals may be misleading.

For instance, it is not unusual for non-farm payroll data to initially exceed expectations, only to be significantly revised downward. On July 5, data from April showed a stark revision from 165,000 jobs created to just 108,000, while May's figures shifted from 272,000 down to 218,000. Such discrepancies far exceed the typical statistical margins of error.

A broader evaluation reveals that the PCE price index indicates a mere reduction in inflation, rather than a decisive defeat of it.

What might be the underlying reasons for the Fed's decision to lower interest rates? Evidence suggests that the liquidity crisis within the U.S. Treasury market has significantly deteriorated, a situation that requires little elaboration on its consequential effects on global financial markets. A rise in volatility is expected as liquidity wanes, escalating market risks and amplifying them through high-frequency trading.

A major fluctuation could trigger a cascade of high-frequency trading errors, leading to swift crashes within the trading system. Additionally, anomalies have surfaced in the repo market, highlighted by a sudden and alarming spike in rates as measured by the Secured Overnight Financing Rate (SOFR).

Some economists have likened this troubling scenario to "angina pectoris" in the heart of the dollar. The anomalies observed since June 25—when SOFR first showed signs of irregular activity—have not yet returned to normal parameters, with concerns growing that a serious issue, akin to a heart attack, looms large.

Moreover, reserves held by banks at the Federal Reserve are exhibiting excessive daytime overdraft growth. In the week of March 6, bank overdrafts surged from an average of $6.6 billion to $11.9 billion, eclipsing figures seen during the 2023 regional banking crisis—marking the highest levels in four years.

This overdraft scenario reveals that banks are withdrawing more funds from the Fed than they have in reserve, creating a short-term liquidity crunch that could spark a payment crisis and potentially lead to insolvency.

Examining the U.S. financial market as a patient reveals a complex diagnosis: a trifecta of cardiovascular issues intertwined, compounding each other and affecting overall system health. This critical "patient" requires intensive care, necessitating medication and possibly surgery; if funding for recovery is insufficient, it must at least rest and recuperate at home.

Yet, the U.S. financial market remains distractingly active, caught in a standoff between opposing pressures. The apparent calm in the Treasury market disguises an underlying volatility, teetering on the brink of instability that threatens to erupt into crisis at any moment.

The mounting pressures on the Federal Reserve are rendering the financial market increasingly fragile. The "Black Wednesday" in late July, coinciding with a "Crazy Thursday" in Beijing, serves as a stark example.

The Treasury Department recognizes the seriousness of market conditions, as evidenced by Treasury Secretary Janet Yellen's escalating anxiety. The Fed's caution in terms of inflation and recent shifts in public opinion among committee members signal an acknowledgment of the substantial risks facing the market.

In summary, the Fed's cessation of balance sheet reduction appears imminent, and interest rate cuts may dramatically exceed market anticipations. The mid-year analysis meeting scheduled for July 27 in Beijing aims to provide a comprehensive evaluation of the health of the U.S. Treasury market, establishing a foundation for understanding and predicting market behavior moving forward. Understanding the trends in gold, currency, stock and bond markets, as well as commodity developments, will unveil opportunities waiting to be seized.