April 19, 2024
Deutsche Bank says size of Fed rate cut could disappoint market

Downward Angle Icon An icon in the shape of an angle pointing downwards. Federal Reserve rate cuts may not happen as quickly as investors expect. Win McNamee/Getty Images

  • Deutsche Bank has written that the market’s expectations of a major cut this year are unlikely to end.
  • Today’s economy is similar to that of 1995, when the cuts fell short of market forecasts.
  • The productivity cycle from AI could keep the US from falling into recession, which would keep rates up.

The market may find the anticipated rate-cut cycle falls short of expectations, Deutsche Bank’s George Saravelos wrote on Friday.

This is not because of its timing, but because interest rates will not fall as aggressively as predicted. Futures markets are forecasting five to six cuts this year, which would result in a Fed funds rate cut of more than 100 basis points by the end of the year.

“In a soft landing scenario, it is reasonable to expect the Fed to cut to nominal neutral,” Saravelos wrote, referring to the rate level that neither restricts the economy nor expands it. “The problem is that no one knows where this theoretical rate is in real time.”

Given this uncertainty, it is likely that the Federal Reserve is headed toward a repeat of 1995, he wrote. That year, the central bank cut rates by 75 basis points, less than expectations for a 200 basis point cut.

Like today’s economy, declining inflation, labor growth, and economic strength involved only minor adjustments about thirty years ago. The technology cycle of the mid-nineties kept the economy moving forward and concerns about a major recession never surfaced.

Saravelos wrote, “Can this experience be repeated? Artificial intelligence stands out as a technology that can help drive a new productivity cycle. We have seen the dramatically reduced interest rate sensitivity of the US economy. Has also been written about.”

So far in the year, the Fed has kept rates in the range of 5.25%-5.50%. At its latest FOMC meeting, it signaled the need to strengthen confidence in deflation before a policy turn.

The bullish arguments may have lost some of their edge after the January jobs report, where new positions nearly doubled expectations. And although some still see recession risks for the broader economy, others have pointed to the strength of continued spending as a tailwind.

Source: www.businessinsider.com

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