Jerome Powell’s Rate Hike Exit Wall Street Plays the Fed Cutting Waiting Game

After interest-rate hikes, Wall Street shifts focus to guessing when the Fed will cut under Jerome Powell's leadership

Even Fed Chair Jerome Powell isn’t raining on the parade of the Wall Street bulls. They are now proclaiming the arrival of an “immaculate disinflation,” thanks to two surprisingly positive inflation reports. Powell’s dovish remarks about the Fed’s progress in taming inflation and the possibility of rate cuts have struck a harmonious chord with Wall Street.

In the midst of this exuberance, the burning question among Wall Street’s top minds is when and by how much will the Fed begin cutting rates? The answer to this question holds the key to the sustainability of the stock market rally and the health of the economy in 2024. Rapid rate cuts could signal a freezing economy that needs to be thawed, while gradual reductions might lead to a soft landing with inflation returning to the 2% target rate without significant job losses.

The neutral rate of interest, known as r*, is the Fed funds rate that neither slows down nor artificially stimulates the economy. According to the December Blue Chip Economic Indicators survey, the neutral Fed funds rate for the current economy is projected to be just 2.6%, less than half of its current level of 5.3%.

So, when will we reach this neutral rate? The timing and depth of interest rate cuts are still up for debate, and it all depends on the twists and turns of the economy in the coming months. Will there be unexpected surges in unemployment? Will consumers tighten their belts?

Opinions on the timing of rate cuts vary. Some experts expect the first rate cut as early as the first quarter of 2024, while others anticipate it in the second quarter. Let’s take a look at the predictions from Wall Street’s finest:

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Goldman Sachs: David Mericle, the chief U.S. analyst at Goldman Sachs, has revised his interest rate cut forecast for next year. He now expects three consecutive 25 basis point rate cuts in March, May, and June. However, the pace of rate cuts remains uncertain, depending on the response of financial conditions.

UBS Global Wealth Management: Solita Marcelli, the chief investment officer of the Americas at UBS Global Wealth Management, cautions against excessive optimism in the market’s expectations. She believes that the Fed will refrain from further rate hikes and start trimming rates by the middle of 2024, with a total of 75 basis points of cuts in the second half of next year.

Citi: Andrew Hollenhorst, the chief U.S. analyst at Citi, shares his concerns about the economy, which align with the dovish stance adopted by the Fed. He predicts a 25 basis point rate cut in July, followed by an additional 75 basis points of cuts by the end of 2024. However, he also notes that the risks of earlier and/or more cuts have increased.

Wells Fargo: Scott Wren, the senior global strategist at Wells Fargo, believes that investors and the Fed are overly optimistic about the number of interest rate cuts in 2024. He argues that the market’s prediction of around 125 basis points of cuts by the end of next year is unrealistic. Wren predicts that the Fed funds rate will end 2024 in a range between 4.75% and 5%.

Bank of America: Michael Gapen, the chief U.S. analyst at Bank of America, correctly predicted the Fed’s forecast of three rate cuts at the December FOMC meeting. He expects multiple rate cuts in the coming years, with the Fed funds rate dropping to 4.6% in 2024 and 3.6% in 2025. However, he also anticipates a jump back to 3.9% in 2026.

Morgan Stanley: Ellen Zenter, the chief U.S. analyst at Morgan Stanley, doesn’t expect the Fed to start cutting interest rates until June. She believes that progress in taming inflation will slow in the first quarter of 2024, delaying the first rate cut.

That’s a lot to chew on! The opinions and predictions are diverse, reflecting the complexity of the economic landscape. So, dear readers, which expert’s crystal ball do you find most convincing? Do you think the Fed will perform a delicate dance of rate cuts, or will it swing the axe with gusto? Share your thoughts and predictions in the comments below!