Navigating the Murky Waters: Decoding the Federal Reserve's Chaotic Rate Cut Signals and Market Implications
Aa
Share
The uncertainty surrounding the Federal Reserve's (Fed) stance on rate cuts has created a complex narrative that demands close attention. As the Fed hinted at a potential halt to its monetary tightening efforts, European policymakers resisted aligning with this sentiment. Notably, Fed members like John Williams and Raphael Bostic have contradicted expectations of a rate cut.
Despite this, Fed funds futures activity indicates a high probability of the first rate cut by March next year, with a more than 75% chance, and a near 100% chance of the first cut in May. The market anticipates around a 150 basis points cut throughout the next year, doubling the 75 basis points cut predicted by Fed officials. This ambitious projection clashes with the current resilience of the US economic growth.
Long Japanese yen
By Ipek Ozkardeskaya, Senior Analyst | Swissquote Bank
The Federal Reserve's (Fed) rate cut talk becomes chaotic and frankly, hard to follow. After the Fed signaled a possible end to its monetary policy tightening campaign and the European policymakers refused to adhere, some Fed members including John Williams and Raphael Bostic pushed back the Fed cut expectations.
Alas, activity on Fed funds futures price in the first Fed cut by March next year with more than 75% chance, and the first cut in May with almost a 100% chance. The market pricing matches the expectation of around 150bp cut throughout next year, versus only 75bp cut foreseen by Fed officials – which is already ambitious given the resilience of the US economic growth. Therefore, either the US economy will do fine, and the Fed won't start cutting rates in March. Or we will see a sharp slowdown in the US growth and a potentially deteriorating growth outlook will force the Fed to start cutting the rates in Q1 and cut thoroughly. But a scenario where the Fed starts cutting rates in March while economy remains resilient and inflation low makes little sense as the fiscal spending will remain robust into next year's presidential election and maintain the risk of a U-turn in inflation alive.
But anyway, investors could give the Fed doves the benefit of the doubt until Friday's PCE data. The PCE, the Fed's favourite gauge of inflation, is expected to show a further decline in both headline and core inflation. More importantly, if the data matches expectations, it would mean that 6-month annualized inflation will be a touch above the Fed's 2% target. The latter could keep the Fed doves in charge. Nonetheless, the successful alleviation of inflation can be attributed to the decline in oil prices. Even though the base case scenario is a limited upside potential in oil prices, any reversal in oil price dynamics could tame the Fed cut expectations. In the short run, the barrel of American oil is around the $72pb on Monday on the back of lower Russian exports and suspended transit in the Red Sea due to attacks by the Houthis on ships in the region. Solid offers are seen into $74/75pb range.
