Impacted by energy price shocks and recurring inflation, expectations for Federal Reserve interest rate cuts this year have significantly cooled. A latest survey shows that most economists believe the Fed will avoid cutting rates this year and have postponed their rate cut expectations to next year. The federal funds rate (currently in the range of 3.50%-3.75%) has remained unchanged since December of last year. Now, less than half of economists expect the rate to be lowered this year, a sharp contrast with the previous month when over two-thirds anticipated at least one rate cut.
Despite this, economists’ overall assessment of the interest rate outlook remains relatively moderate, with a general belief that the inflation triggered by soaring energy prices since the outbreak of the Iran conflict two and a half months ago is “transient” and unlikely to spread broadly to prices of other consumer goods.
In a survey conducted from May 14 to 19, nearly 85% (83 out of 101 economists) expect the benchmark interest rate to remain unchanged in its current range until the third quarter. Aditya Bhave, Head of U.S. Economic Research at Bank of America, said: “Both a rate hike and a rate cut are possible… The baseline scenario is to keep rates unchanged. If the Fed’s next move is a rate cut, it is more likely to happen next year rather than this year.” However, he added that upside risks to inflation do exist.
Contrary to economists’ expectations, the bond market had priced in a rate hike from the Fed within this year. Stimulated by inflation data, the 30-year Treasury yield has breached 5%, and the 10-year Treasury yield once climbed to a 15-month high above 4.6%. Federal funds futures had at one point pushed the probability of a rate hike this year to around 50%.
Many strategists have expressed doubts about this, pointing to an apparent “overreaction.” Will Compernolle, a macro strategist at FHN Financial, noted that far-month futures contracts are extremely illiquid, calling them a “low-confidence signal.” Ryan Swift, Chief U.S. Bond Strategist at BCA Research, also said that financial markets sometimes capture correct signals in advance, but “more often than not, it’s an overreaction.”
Economists believe that inflation remains the biggest variable. The Fed’s preferred inflation gauge, the Personal Consumption Expenditures (PCE) price index, posted a latest annual rate of 3.5%, the highest since May 2023. Economists now expect the index to rise 3.9%, 3.7%, and 3.4% year-over-year in the second, third, and fourth quarters, respectively, marking the third consecutive upward revision of expectations. In a smaller sample survey, nearly 86% of respondents believe the current inflationary pressures are transitory. Scott Anderson, Chief U.S. Economist at BMO Capital Markets, admitted: “Our recent track record on inflation forecasts hasn’t been good… We may be in a new era.” Economists’ expectations for the unemployment rate and economic growth remain largely unchanged.
