Wall Street pushes out rate-cut expectations, sees risk of no action until 2025

If there was any doubt before, Federal Reserve Chairman Jerome Powell has largely cemented the likelihood that there won’t be an interest rate cut anytime soon.

Today, Wall Street is wondering whether the central bank will make cuts this year.

Indeed, Powell said Tuesday that there was “a lack of further progress” in bringing inflation back to the Fed’s 2% target, meaning “it will likely take longer than expected.” to gain enough confidence to start relaxing its policies.

“They’ve got the economy where they want it. They’re now just focused on the inflation numbers. The question is, what’s the bar here?” said Mark Zandi, chief economist at Moody’s Analytics. “I feel like they need two, probably three consecutive months of inflation numbers in line with the 2% target. If that’s the bar, they won’t be able to get there sooner rather than later in September. I just don’t see a rate cut before then.”

With most numbers putting inflation around 3% and not changing appreciably for several months, the Fed finds itself with a difficult task on the last mile to its goal.

Market pricing for rate cuts has been highly volatile in recent weeks as Wall Street chases the Fed’s fluctuating rhetoric. As of Wednesday afternoon, traders were pricing in a roughly 71% chance that the central bank would indeed wait until September, with an implied chance of a July cut at 44%, according to the CME Group’s FedWatch indicator.

As for a second rate cut, the trend has been toward such a cut in December, but that remains an open question.

“Right now, my base case is two – one in September and one in December, but I could easily see a rate cut, in November,” said Zandi, who thinks the presidential election could come into the equation for Fed officials who insist they are not influenced by politics.

Uncertainty spread to the streets. Market-implied odds of no cuts this year were around 11% as of Wednesday, but that possibility can’t be ignored at this point.

For example, Bank of America economists said there is a “real risk” that the Fed won’t cut spending until March 2025 “at the earliest,” though for now they’re still sticking to a December forecast for this date and only reduce this period. year. At the start of 2024, markets were pricing in cuts of at least six quarters of a percentage point.

“We believe policymakers will not feel comfortable starting the cycle of budget cuts in June or even September,” Stephen Juneau, an economist at BofA, said in a client note. “In short, this is the reality of a data-driven Fed. With inflation data beating expectations for the start of the year, it’s no surprise that the Fed is putting off any urgent rate cuts , especially given the strong activity data.

Certainly, there remains hope that inflation data will fall over the coming months and give the Fed room to ease.

Citigroup, for example, still expects the Fed to begin easing rates in June or July and to cut rates several times this year. Powell and his fellow policymakers “will be pleasantly surprised” by inflation data in the coming months, wrote Citi economist Andrew Hollenhorst, who added that the Fed “is prepared to cut rates either due to a year-over-year slowdown in core inflation or any signs of weakness.” in activity data.”

Separately, Goldman Sachs pushed back the month in which it expected policy easing, but only from July to June, as “the broader disinflationary narrative remains intact,” wrote Jan Hatzius, chief economist at the society.

If true, then “the pause on rate cuts would be lifted and the Fed would move forward,” wrote Krishna Guha, head of the global policy and central bank strategy team at Evercore ISI. However, Guha also highlighted the wide range of policy possibilities opened up by Powell in his remarks on Tuesday.

“We think this still leaves the Fed uncomfortably data-dependent and highly vulnerable to a three-to-two-to-one reduction if near-term inflation data doesn’t cooperate,” he added.

The possibility of a stubborn Fed raises the possibility of policy error. Despite the economy’s resilience, higher rates for a prolonged period could threaten the stability of the labor market, not to mention sectors of the financial sector such as regional banks which are sensitive to the duration risk posed to bond portfolios.

Zandi said the Fed should have already cut inflation well back from its mid-2022 highs, adding that housing factors are essentially the only thing standing in the way of the Fed and its inflation target of 2%.

A policy mistake by the Fed “is the biggest risk to the economy at this point. They’ve already met their mandate on full employment. They’ve almost met their mandate on inflation,” Zandi said.

“Things are happening and I think we need to be humble when it comes to the financial system,” he added. “They run the risk of breaking something. And to what end? If I were on the committee, I would emphatically say that we should get going already.”