Fed rate cuts: Expect 200 basis points of easing as economy slows more sharply

According to analysts at Citi Research, get ready for the Federal Reserve’s rate cuts, which will begin in a few months and extend into next summer.

In a note on Friday, the bank said the Fed would cut rates by 25 basis points eight times between September and July 2025, citing new signs of a slowing economy in its view.

This would cut the benchmark rate by 200 basis points, or 5.25%-5.5%, to 3.25%-3.5%, where they will remain by late 2025, the note said.

Citi analysts led by U.S. Chief Economist Andrew Hollenhorst said the economy had cooled from its „upside” momentum in 2023, with inflation resuming its slowdown after some unexpected contractions.

But the Institute for Supply Management’s service-sector gauge, which suddenly shifted into negative territory and a monthly jobs report that showed unemployment rose to 4.1%, raised the risk of economic activity weakening sharply and the pace of rate cuts accelerating. , they added.

The data, along with dovish comments from Fed Chair Jerome Powell on Tuesday, suggest the first rate cut could come in September.

„Continued easing of activity would trigger cuts at the next seven Fed meetings, in our base case,” Citi predicted.

The note also pointed to other signs of weakness in the jobs report. While the headline wage gain of 206,000 looked solid, the previous months were reduced. Temporary services jobs saw a decline of 49,000 in June, the Citi said, „the type of decline typically seen around recessions as employers begin to cut back on labor with less-connected workers.”

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Wage data may also reverse, leaving the unemployment rate, which is derived from a separate survey, the most important metric, it said. And on that front, Citi pointed to the „Sahm ​​Rule” recession indicator, which he said could be triggered in August if unemployment continues to rise at its current pace.

Hallenhorst remained relatively contrarian by maintaining a dim view on the economy this year, even as the Wall Street consensus shifted toward a soft landing.

In May, he doubled down on his warning that the US was headed for a hard landing and that central bank rate cuts would not be enough to prevent it. This followed a similar forecast in February, even amid explosive jobs reports.

In an interview Bloomberg TV on Wednesday, Hollenhorst noted that a severe recession would create enough political consensus for more government spending to stimulate the economy, overcoming concerns about massive deficits. But a very mild recession would not create such a consensus, he added.

He also pointed out that while the central bank’s rate hikes have dampened the economy less than expected, rate cuts have been less encouraging. Additionally, 10-year bond yields, which serve as benchmarks for a broad range of borrowing costs, are already below 2-year yields, leaving little room for downside, especially as rising deficits and inflation add upward pressure.

„Most economic activity is more responsive to the 5-year yield than the 10-year yield. It’s not really about the overnight policy rate,” Hollenhorst explained. „So there are really questions about how much you can pass on the stimulus effect of lower policy rates.”

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