Get ready for a surprise cut in interest rates starting in a few months and potentially extending into next summer, according to analysts at Citigroup Inc.
In a recent note, the bank cited fresh signs of a slowing economy that would prompt the Fed to cut interest rates by 25 basis points eight times, beginning in September and continuing through July 2025.
The memo indicated that this would reduce the interest rate by 200 basis points, from the current 5.25%-5.5% to 3.25%-3.5%, where it would remain for the rest of 2025.
Economy Slows, Powell Speech Coming
Citi analysts, led by chief US economist Andrew Hollenhorst, stated that the economy had slowed amidst easing inflation pressures following some unexpected volatility.
However, the Institute for Supply Management’s services PMI, which unexpectedly entered negative territory, and the monthly jobs report, which revealed unemployment rising to 4.1%, raised concerns regarding a sharp weakening in economic activity leading to a faster pace of interest rate cuts, according to Citi analysts.
The data, coupled with dovish comments from Federal Reserve Chairman Jerome Powell in recent days, suggest that the first rate cut is highly likely to occur in September.
Federal Reserve Chairman Jerome Powell is scheduled to deliver his semiannual briefing to Congress on Tuesday. While no new announcements are expected, his remarks will be closely scrutinized for clues regarding the Fed’s stance on inflation and future rate changes.
Analysts at Piper Sandler note that Powell will emphasize the “significant” progress made in curbing inflation but will also highlight the need for more work to achieve a sustainable 2% inflation rate.
Powell is expected to address challenges to “confidence” in inflation expectations, signaling vigilance once morest potential downsides.
According to Piper Sandler, the testimony is likely to address the “best,” albeit incomplete, balance of risks surrounding the Fed’s mandate. Additionally, they note that Powell may touch on the possibility that unexpectedly weak employment might lead to an early easing of monetary policy, especially if disinflationary trends continue to be positive.
Citi expects that “continued weakness in economic activity will lead to rate cuts at each of the next seven Fed meetings.”
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Other signs of weakness
The note also highlighted other signs of weakness in the jobs report. While the headline figure of 206,000 jobs appears strong, previous months were revised downward. June witnessed a 49,000 decline in gig economy jobs, which Citi described as “the kind of decline we typically see in recessions as employers begin to cut back.”
Citi also pointed to the “arrow base” recession indicator, which it said might be activated in August if unemployment continues to rise at the current pace.
Hollenhorst has been relatively contrarian this year due to his conflicting views on the economy. In May, he doubled down on his warning that the U.S. was headed for a hard landing and that interest rate cuts by the Federal Reserve would not be enough to prevent it. This followed similar predictions in February, even amid strong jobs reports.
In an interview with Bloomberg Television on Wednesday, Hollenhorst suggested that a severe recession would likely create enough political consensus for more government spending to stimulate the economy and overcome concerns regarding the massive deficit. However, he added that a mild recession might not produce such a consensus.
He also noted that while the Fed’s rate hikes have slowed the economy less than expected, rate cuts won’t stimulate economic activity as much. Moreover, the 10-year Treasury yield, which serves as a benchmark for a wide range of borrowing costs, is already lower than the 2-year yield, leaving less room for further declines, especially as rising deficits and inflation add upward pressure.
Citigroup Predicts Surprise Interest Rate Cuts: Here’s What Investors Need to Know
Citigroup Inc. analysts are predicting a series of interest rate cuts by the Federal Reserve, starting as early as September and continuing through next summer. This surprising move has been prompted by fresh evidence indicating a weakening economy.
Economic Slowdown Fueled by Multiple Factors
Citi analysts believe the economy has slowed due to easing inflation pressures, coupled with unforeseen volatility. Several key economic indicators have contributed to this prediction:
- Institute for Supply Management’s (ISM) services PMI: This index plunged into negative territory, signaling a decline in the service sector.
- Monthly Jobs Report: The latest report revealed an unemployment rate climb to 4.1%, further indicating a slowdown in economic activity.
- Dovish comments by Federal Reserve Chairman Jerome Powell: Recent comments made by Powell suggest a leaning towards easing monetary policy.
These factors, particularly the unexpected slump in the jobs report, are driving Citi analysts to conclude that the Fed will need to cut interest rates more aggressively.
Powell’s Testimony: A Window into Future Policy
Federal Reserve Chairman Jerome Powell is scheduled to deliver his semiannual testimony to Congress on Tuesday, July 11th, 2023. While no significant announcements are expected, his remarks will be scrutinized for clues regarding the Fed’s stance on future rate changes.
Analysts at Piper Sandler anticipate that Powell will emphasize the progress made in curbing inflation, while also underscoring the need for further action to reach a stable 2% inflation rate. Notably, Powell is expected to address challenges related to "confidence" in inflation expectations, highlighting a continued cautious approach.
According to Piper Sandler, Powell’s testimony will likely focus on the “best,” albeit incomplete, balance of risks surrounding the Fed’s mandate. Additionally, they note that Powell may address the possibility that unexpectedly weak employment figures might lead to an earlier easing of monetary policy, particularly if disinflationary trends continue.
Citigroup’s Prediction: A Series of Rate Cuts
Citigroup forecasts that "continued weakness in economic activity will lead to rate cuts at each of the next seven Fed meetings." The bank anticipates eight rate cuts totaling 200 basis points, reducing the target range from the current 5.25%-5.5% down to 3.25%-3.5% by July 2025.
Other Signs of Economic Weakness
Beyond the recent jobs report, Citigroup highlights further signs of a slowing economy:
- Revised Downward Job Figures: While the headline figure for June’s jobs report showed 206,000 new jobs, previous months were revised downward.
- Decline in Gig Economy Jobs: June saw a 49,000 decrease in gig economy jobs, a sign often associated with economic downturns as employers cut back.
- “Arrow Base” Recession Indicator: Citigroup warns that this indicator might be triggered in August if unemployment continues to rise at its current pace.
Hollenhorst’s Contrarian View and Potential Consequences
Citigroup’s chief US economist, Andrew Hollenhorst, has been a vocal proponent of a looming recession. In May, he reinforced his warning of a "hard landing" for the U.S. economy, asserting that rate cuts by the Fed would be insufficient to prevent it. These predictions echo his earlier statements made in February.
In a recent interview with Bloomberg Television, Hollenhorst suggested that a severe recession might lead to increased government spending aimed at economic stimulation, potentially overcoming the concerns surrounding the massive deficit. However, he noted that a milder recession might not garner the same political consensus for such measures.
Hollenhorst also pointed out that while the Fed’s rate hikes have had a less impactful slowdown on the economy than anticipated, rate cuts may not stimulate economic activity as effectively. Moreover, the 10-year Treasury yield, a benchmark for borrowing costs, is already lower than the 2-year yield, leaving limited room for further decline, particularly given the upward pressure from rising deficits and inflation.
Key Takeaways for Investors: Navigating Uncertain Times
- Anticipate Fed Rate Cuts: Citigroup’s prediction of a series of rate cuts poses a significant development for investors.
- Monitor Economic Indicators: Closely track economic indicators, including the jobs report, inflation data, and Powell’s statements, for insights into the Fed’s policy direction.
- Consider Diversification: Diversifying portfolios across various asset classes can help mitigate potential risks and capitalize on opportunities during economic uncertainty.
- Consult Financial Professionals: Seek guidance from financial professionals to navigate market volatility and make informed investment decisions.
