Citi says Wall Street is wrong to slash Fed rate-cut bets
Economists at Citigroup are going out on a limb by wagering that virtually everyone on Wall Street is wrong about the Federal Reserve (Fed). In the past three months, inflation rates have been slightly higher than anticipated. As a result, banks like Bank of America Corp, Goldman Sachs Group, and Morgan Stanley are adjusting their predictions for interest-rate cuts this year. Fed Chair Jerome Powell reinforced this stance on April 16, indicating that policymakers are not rushing to implement policy changes.
Citigroup’s Andrew Hollenhorst and Veronica Clark argue against hastily dismissing concerns, noting the Fed’s ongoing worry that the unexpectedly robust economic growth might slow down. They maintain their prediction of five quarter-point interest rate cuts this year, emphasising policymakers’ readiness to respond to any indications of disinflation or economic downturn.
“We’ve been thinking about the economy’s trajectory in 2024 very differently from other forecasters,” Hollenhorst, who has consistently built sticky inflation expectations into his estimates this year, said in an interview. “We think the Fed’s reaction function is much more dovish than the consensus.”
The bank’s forecast diverges from the prevailing sentiment in financial markets. Bond yields surged following last week’s consumer price index report, prompting investors to reassess their expectations. In the derivatives market, traders assign only about a 10% probability to a rate cut in June and question whether the Fed will implement two quarter-point reductions this year.
According to Citigroup economists, the current shift might be another case of underestimation. Key to their view is the upcoming readings of the core personal consumption expenditures index, a measure of inflation that the Fed favours. The Citigroup economists expect it to show some cooling of price pressure. If the index shows monthly gains of only 0.25% in March and April — roughly where it was in February — the Fed will find “cover to begin ‘gradually’ adjusting policy rates lower starting in June or July,” the economists said.
Citi expects the Fed will prioritise signs of economic weakness, such as a job market slowdown or over-ongoing strength, citing a perceived bias towards policy easing within the bank. “Despite a professed lack of ‘urgency,’ Powell and the committee are anxious to begin adjusting policy rates lower,” Hollenhorst and his colleagues wrote in an April 17 note. “The dovish asymmetry of the Fed’s reaction function appears underpriced by interest rate markets.” —