Wall Street rejects expectations for rate cuts and sees the risk of no action until 2025

If there was any doubt, Federal Reserve Chairman Jerome Powell has all but confirmed the likelihood that there will be no rate cuts anytime soon.

Now Wall Street is wondering whether the central bank will cut spending at all this year.

That’s because Powell said Tuesday there is “a lack of further progress” in pushing inflation back toward the Fed’s 2% target, meaning “it will likely take longer than expected” for enough confidence to build to relax the policy again.

“They have the economy exactly where they want it. They are now just focused on inflation numbers. The question is: what is the bar here?” says Mark Zandi, chief economist at Moody’s Analytics. “My feeling is that they need two, probably three straight months of inflation numbers consistent with that 2% target. If that’s the bar, then September is the earliest they can get to it. I just don’t see rate cuts for that.”

With inflation hovering around 3% by most metrics and no significant movement in recent months, the Fed is in a tough spot on the way to its goal.

Market prices for rate cuts have been highly volatile in recent weeks as Wall Street has chased fluctuating Fed rhetoric. As of Wednesday afternoon, traders had priced in a roughly 71% probability that the central bank would indeed most likely wait until September, with the implied probability of a July cut at 44%, the report said. FedWatch from CME Group indicator.

As for a second rate cut, there was a trend towards a rate cut in December, but that remains an open question.

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

The uncertainty has spread through the street. The market-implied chances that there would be no cuts this year were around 11% on Wednesday, but the possibility cannot be ignored at this point.

Bank of America economists, for example, said there is a “real risk” that the Fed won’t make cuts until March 2025 “at the earliest,” although for now they are still looking at a December forecast for the only real cut to occur. year. By the start of 2024, markets had priced in a cut of at least six quarters of a percentage point.

“We think policymakers will be uncomfortable if the austerity cycle begins in June or even September,” BofA economist Stephen Juneau said in a client note. “In short, this is the reality of a data-dependent Fed. With inflation numbers exceeding expectations at the start of the year, it is no surprise that the Fed will reduce the urgency to cut spending, especially given the strong economic activity data. “

To be fair, there is still hope that inflation rates will turn out lower in the coming months and give the central bank room to ease.

Citigroup, for example, still expects the Fed to start easing in June or July and cut rates several times this year. Powell and his fellow policymakers “will be pleasantly surprised” by inflation numbers in the coming months, wrote Citi economist Andrew Hollenhorst, who added that the Fed “is poised to cut rates based on lower annualized core inflation or signs of weakness. in activity data.”

Elsewhere, Goldman Sachs has postponed the month in which it expects policy easing to take place until July, as “the broader disinflationary narrative remains intact,” wrote Jan Hatzius, the firm’s chief economist.

If true, “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 noted the wide range of policy options Powell opened up in his remarks on Tuesday.

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

The possibility of a stubborn Fed brings with it the possibility of a policy error. Despite the resilient economy, longer interest rates could threaten the stability of the labor market, not to mention areas of the financial sector such as regional banks that are sensitive to the duration risk of fixed income portfolios.

Zandi said the Fed should have already cut spending with inflation well above its mid-2022 boiling point, adding that housing-related factors are essentially all that stands between the central bank and its 2% inflation target .

A Fed policy error “is the biggest risk to the economy right now. They have already achieved their full employment mandate. They have pretty much achieved their mandate on inflation,” Zandi said.

“Things are happening, and I think we have to be humble here when it comes to the financial system,” he added. ‘They run the risk of breaking something. And for what purpose? If I were on the committee, I would strongly argue that we should go now.”