Markets seem overly optimistic about Fed rate cuts as critical data has yet to show meaningful disinflation.
The Fed remains committed to combating the renewed inflation, a scenario that’s underpriced by markets and has the potential to inject downside volatility into risky assets.
Financial markets may be overly optimistic about how soon and how fast the U.S. Federal Reserve (Fed) will ease policy through interest rate-cuts this year, according to JPMorgan Asset Management.
Expectations of lower rates became widespread as inflation receded in 2023 and the Fed hinted at a pivot to rate cuts at its December meeting. According to the Fed funds futures market, traders are anticipating 140 basis points of rate cuts this year, nearly double the amount signaled by the Fed’s interest-rate projections chart, the so-called dot plot, in December.
However, critical areas of inflation closely tracked by the Fed have yet to show meaningful signs of disinflation, according to JPMorgan Asset Management’s macro strategy team led by Shrenick Shah. The Fed’s commitment to combating a potential rebound in inflation remains underappreciated, leaving the door open for a correction in risk assets, they said.
The Fed is set to publish the first rate review of the year later Wednesday. The central bank is likely to keep the benchmark interest rate steady between 5.25% and 5.5% and push back against heightened dovish expectations considering renewed inflation risks.
“In our view, the market may be too optimistic as we see limited evidence of disinflation in certain areas that are a focus for the Fed, specifically core services inflation and wage data,” the strategists wrote in a note titled “Macro Strategies Outlook” earlier this month. “Furthermore, continued resilience in U.S. growth may inhibit the disinflation process or even create upward pressure.”
Bitcoin has historically moved more or less in line with stocks, falling on the back of hawkish Fed developments. The cryptocurrency’s fourth-quarter surge of 57% was partly fueled by rate-cut expectations and weakness in the U.S. dollar index.
“While we do believe the Fed will stand ready to defend any emerging weakness in 2024, we also believe it remains committed to combatting inflation and would not hesitate to act if it were to rise again. We see this potential scenario as underpriced in markets and, if acknowledged, it may spark a correction down in risk assets and support bond yields,” the strategists wrote.
