Market ‘underappreciates’ that the Fed will cut rates for one reason or another

According to a recent research note from Citi analysts, the market is potentially overlooking the Federal Reserve’s inclination to reduce interest rates in the near future, citing reasons related to inflation and economic activity. The note highlights Chairman Powell and the Federal Open Market Committee’s (FOMC) eagerness to initiate a downward adjustment in policy rates, despite their outward lack of urgency.

Analysts suggest that maintaining higher interest rates for an extended period could heighten the risk of a recession. However, they argue that any rate cuts hinge significantly on the performance of core inflation data. Thus far in the year, core inflation has not aligned with expectations conducive to rate cuts.

Chairman Powell recently indicated that core Personal Consumption Expenditures (PCE) inflation persisting at 2.8% year-over-year (YoY) in March could warrant a delay in rate reductions. However, Citi’s projections diverge, anticipating core PCE inflation to be slightly lower at 2.7% YoY by the end of the month. Furthermore, they foresee a potential decline to 2.6% YoY in April, with this data release falling after the May FOMC meeting but before June.

The note emphasizes that the market’s current anticipation of only 40 basis points (bp) in rate cuts by 2024 may not fully appreciate the Federal Reserve’s readiness to adjust rates based on evolving inflation trends or any indications of economic softness. Citi’s analysis suggests that a more substantial rate adjustment could be warranted, either due to a slowdown in year-on-year core inflation or signs of weakness in economic activity.

This perspective underscores ongoing uncertainties in the macroeconomic environment and highlights the Federal Reserve’s proactive stance in responding to potential economic headwinds. The market’s interpretation of future rate movements, as per Citi’s analysis, may underestimate the Fed’s willingness to act decisively based on incoming economic data.