A version of this story was first published in sister title, AsianInvestor.
While the financial markets have been moving in a way that implies many investors have placed their bets on the Federal Reserve starting to cut rates some time later this year, others have been less enthusiastic about that view.
William Chan CIO of HSBC Life is one such investment professional; he recently cautioned that such rate cuts may not be forthcoming very soon.
Speaking at AsianInvestor’s 18th Asian Investment Summit, Chan said that despite the potential for an economic downturn in the US prompting rate cuts, there appears to be no hard data to support such a move for now. The US economy has proven more resilient to interest rate hikes than expected, he said.
Investors will need to keep a close eye on data releases in the coming months, as the markets may shift their expectations depending on what happens, he said.
Overall, the potential risks for markets if the Federal Reserve does not signal a softening in policy by September could be significant.
At this point, no clear picture has emerged of which way the Fed will go.
AsianInvestor asked industry leading asset managers and economists how they see the situation unfolding and whether they expect the Federal Reserve to cut interest rates this year.
The following responses have been edited for clarity and brevity
Blerina Uruci, chief US economist
T. Rowe Price
Given the underlying resilience of the US consumer and labor markets, I believe that further interest rate increases may be needed.
However, with policy already being restrictive, more spaced-out hikes seem appropriate. At the same time, the recent improvement in housing data shows that the Fed still has to fight the inflation battle.
For this reason, I remain strongly convicted that policy easing is not likely on the cards this year.
Chair Powell and the Fed leadership sounded more dovish recently. Therefore, I expect “a skip” during the June meeting followed with a discussion that another rate hike could be possible later this year.
I think the language around data dependency means that they will respond to the trend in the data and shift monetary policy to a slower pace, where further hikes could be delivered at every other meeting or after assessing the effects of monetary policy and banking stress over the summer months.
The Fed could also take an extended pause if inflation is travelling to right direction.
We are at a different place in the hiking cycle than we were last year.
I think that the inflationary environment is such that the Fed will not be in a position to cut interest rates anytime soon.
When I look back at 2022, I think of it as the year when the market kept pricing a Fed pause too soon.
Daniel Morris, chief market strategist
BNP Paribas Asset Management
The fundamental issue is that inflation remains high in the US. It is falling, but not necessarily at a fast enough pace for the Fed.
The high inflation reflects, among other things, surprisingly resilient growth, particularly in the labour market.
Even after one of the fastest hiking cycles in US history, the unemployment rate is at historical lows. The resulting wage gains are keeping services inflation elevated.
Therefore, we believe the Fed will need to hike further in order to slow economic growth and reduce the inflation pressures coming from the labour market.
Towards the end of the year, however, the Fed should be able to start cutting rates, but only slowly and by less than the market forecasts, and by the less than indicated by the Fed’s latest “dot plot” of rate projections.
Andrew Zurawski, chief economist, investments Asia
WTW
Our forecasts for economic growth in the US for the second half of 2023 suggest a downturn in growth. It is uncertain whether that will just be a slowdown, a shallow recession, or a deeper recession.
These are scenarios we consider probable in the current environment.
The key driver of weaker growth will be the impact of much higher US policy rates than we had a year ago.
The pace of rate increases has been unprecedented compared to previous cycles of tightening and this should slow consumption, investment and weaken the housing market further.
Recent data has also shown that headline inflation has peaked in the US although core inflation measures remain stubbornly high.
The main indicator we are looking at in terms of more persistent inflationary pressures going forward is the labor market which remains very tight.
The Federal Reserve Board has been quite clear in recent communications that they will need to see a softening of the labor market and wage growth – the most persistent driver of medium-term inflation – before we see any easing of policy rates. This has yet to occur.
Putting this altogether, we believe the Federal Reserve is likely to raise rates by another 25 basis points at the next committee meeting and is unlikely to cut before the end of the year.
Marcella Chow, global market strategist
JP Morgan Asset Management
While some investors believe the Fed ended the rate hiking cycle at its recent May FOMC meeting, we think the current economic slowdown is not sufficient to convince the Fed to reverse policy course just yet, especially as we think containing inflation remains as the top priority for the Fed now.
The market is now pricing in one full hike over the next two meetings (39% chance in June, 69% chance in July).
Whereas only a month ago the market anticipated three full cuts in 2023 following May’s FOMC meeting, they are now pricing in only one full cut from peak rates by year-end, particularly as the labor market and the economy in general are trending towards a soft landing.
Preston Caldwell, senior US economist - equity analysis
Morningstar
I do expect the Fed to start cutting in December 2023 and continue aggressively in 2024 and 2025, bringing the fed funds to well below 2% by 2025.
We think the Fed will receive the green light from falling inflation to pivot back to easing by the end of 2023. The Fed will need to lower interest rates to avert a greater fall in housing activity and eventually generate a rebound.
Likewise, while we don’t expect a crisis, the banks are showing signs of strain from higher rates and are set to contract lending over the next year.
Our long-run expectation (2027 and thereafter) is 1.75% for the fed funds rate and 2.75% for the 10-year treasury yield.
Factors such as aging demographics, slowing productivity growth, and increasing inequality have acted to push down real interest rates for decades, and these forces haven’t gone away.
Regardless of what happens in the next few years, we expect interest rates to ultimately settle back down at the low levels prevailing prior to the pandemic.
Nixon Mak, head of Hong Kong pensions & solutions strategist, Asia Pacific
Invesco
The Fed will likely raise interest rates further in the foreseeable future as inflation remain sticky and strong, as we have seen in the latest economic releases including core personal expenditure and CPI figures.
However, the number of rate hikes may be limited to 1 to 2 times before we see a pause, as the March banking crisis helped to create a reasonable amount of tightening for the Fed.
Survey results from the Senior Loan officer opinion on bank lending has clearly demonstrated that it is getting difficult to obtain commercial or industrial loans.
This is basically the intention of Fed to reduce lending and allow the transmission mechanism to compress aggregate demand in order to cool down inflation indirectly.
It is widely accepted that it will take time for inflation to come down so the direction of monetary policy will likely stay higher for longer.
As such, we are not expecting any rate cut in 2023.
Jack Janasiewicz, portfolio manager and lead portfolio strategist
Natixis Investment Managers Solutions
More recently, the market has repriced its interest rate outlook, expecting no cuts by year-end and moving towards a slightly better than 50:50 odds for a June hike.
The probability for a pause at the next meeting is certainly in play but seeing that we still have one employment report and one inflation print to come between now and then, the verdict is still out.
While there is ample cover for the Fed to take a pause at the next meeting, a pause should not be conflated with an end to the hiking cycle.
And it is certainly not the precursor to subsequent rate cuts either. As the Fed has repeatedly stressed, they are data dependent and we take them at their word.
With core inflation seemingly stuck at 5.5%, the labour market remaining firm and consumer spending resilient, it’s hard to envision a shift by the Fed to outright rate cuts.
If anything, expect the Fed to pause and leverage a higher for longer mantra. But additional hikes in the future cannot be ruled out should the economic data continue to remain resilient. Simply put, the Fed’s work is not done.
Rob Almeida, global investment strategist and portfolio manager
MFS Investment Management
A tremendous amount of effort and ink has been spent on determining the timing of peak central bank policy rates. The current consensus is we’re near the peak.
Even if the US Federal Reserve hikes another 25 or 50 basis points or cuts 50 or 75 basis points later this year, the damage to the economy and company fundamentals has already been done.
Whether we’re at peak or not won’t change the trajectory of bankruptcy filings and lower returns on capital.
Most companies’ largest cost item is labour, which remains in short supply and doesn’t show any signs of changing given the multi-decade low unemployment readings in the United States and eurozone.
What is most relevant to financial assets is future cash flows — i.e., profits.
And I think the market is set up for disappointment, at least for the stocks and bonds of companies who were able to inflate margins on the back of low rates and cheap labour.
Ronald Temple, chief market strategist
Lazard
With US core consumer price inflation at 5.5%, 1.7 unfilled jobs for every unemployed person, and 322,000 new jobs per month through April, one would expect more Fed tightening.
Surprisingly, markets are suggesting the opposite with rate cuts beginning by year-end.
This seemingly irrational outlook took hold after a “run on the bank” at Silicon Valley Bank and other high-profile peers which led markets to forecast imminent recession that would force the Fed to ease policy. There are some signs of economic weakness, no doubt, but in aggregate, the health of the US remains resilient.
Putting it all together, I expect at least one additional rate hike and believe the Fed is likely to keep rates elevated well into next year.
Robert Hong, head of fixed income credit Asia
StoneX
It’s important to remember that whilst the US President and the House Speaker reached an agreement in principle over the weekend, no new legislation regarding the debt ceiling has been approved yet – that’s up to the Congress to decide this Wednesday which is the earliest possible time to call a vote.
If there is a deadlock in Congress and no resolution is reached, the Fed may have to pause given the next rate decision is due in mid-June.
Because of this uncertainty, the market is presently reflecting a single 25bp hike across June and July FOMC meetings.
Looking at recent financial market performance and ‘Fedspeak’ generally, the market is now pricing in more of a continued rate-hiking scenario for the rest of 2023.
Unless we see this new proposed legislation voted down this week, the market is likely to continue pricing in higher US rates as we approach the third quarter.
