Economists at Citigroup Inc are going out on a limb by wagering that virtually everyone on Wall Street is wrong about the Federal Reserve.
After three straight months of slightly faster-than-expected inflation readings, rivals at Bank of America Corp, Goldman Sachs Group, Morgan Stanley, and other banks have dialled back their forecasts for interest-rate cuts this year. Chair Jerome Powell lent support to those moves on Tuesday, when he signalled that policymakers are in no hurry to ease policy.
But Citigroup’s Andrew Hollenhorst and Veronica Clark say that the rush-to-judgment is misguided because the Fed remains concerned that the surprisingly strong run of economic growth could stall. As a result, the two are sticking by their forecast for five-quarter point cuts this year, saying policymakers are eager to seize on any signs of disinflation or economic weakness.
“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 a lot more dovish than the consensus.”
The bank’s forecast stands in contrast to the broader sentiment in financial markets, where bond yields surged after last week’s consumer price index report drove investors to recalibrate their expectations. In the derivatives market, traders are pricing in a roughly 10% chance of a first rate cut in June and doubt whether the Fed will even enact two quarter-point reductions this year.
The markets, however, have consistently struggled to predict where the Fed has been headed over the past few years — both underestimating how much it would tighten and how soon it would reverse course. If Citigroup’s economists are correct, the latest turn may be just another misstep.
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Key to their view is the upcoming readings of the core personal consumption expenditures index, a measure of inflation that’s favored by the Fed. 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 also expects that the Fed will give more weight to any signs of economic weakness — like a slowdown in the jobs market — than it will to data showing continued strength, given what they see as a bias within the bank toward easing policy.
“Despite a professed lack of ‘urgency,’ Chair Powell and the committee are anxious to begin adjusting policy rates lower,” Hollenhorst and his colleagues wrote in a Wednesday note. “The dovish asymmetry of the Fed’s reaction function appears underpriced by interest rate markets.”
