The rising likelihood of an economic recession has pushed two-year US Treasury yields to their lowest point for the year. This decline has led investors to expect the central bank to cut interest rates by more than 0.75%, Citi indicated in its report on Friday.
Citi believes that the market’s expectation of a significant reduction in interest rates is justified by the inconsistent options available to the US Federal Reserve.
Citi predicts that the Federal Reserve will likely cut interest rates by 0.25% at each meeting, even if the economy slows modestly. However, Citi analysts also point out that the Federal Reserve may cut interest rates by 0.50% in one or more meetings if economic conditions deteriorate faster than expected.
The bank’s forecasts depend on upcoming economic data, especially the jobs report. Citi estimates there will be 150,000 new jobs and the unemployment rate could rise to 4.2%. In fact, the unemployment rate rose to 4.3%, with the number of new jobs in the non-agricultural sector reaching 114,000.
The bank points out that Jerome Powell, chairman of the Federal Reserve, said that with interest rates above 5%, the Federal Reserve has a strong ability to face any unexpected economic challenges.
Analysts note that recent economic signals, such as an increase in the number of new unemployment insurance claims to 249,000 and a drop in the Institute for Supply Management’s manufacturing index to 46.8, indicate that the Federal Open Market Committee (FOMC) may have to reduce interest rates by at least 0.25% in its next meeting, and maybe more.
Citi says current interest rates are slowing the economy and causing the unemployment rate to rise. With the labor market now as flexible as it was before the pandemic, the FOMC should not let the unemployment rate continue to rise significantly.
Analysts suggest that to avoid this, the Federal Reserve may need to adopt a balanced policy, with interest rates around 3%. If the economic data continues to deteriorate, this change may occur more quickly.
To protect the economy and maintain a strong labor market, the Federal Reserve must make financial conditions more favorable, Citi wrote. However, financial conditions are currently becoming tighter even as the Federal Reserve plans to cut interest rates.
As a result, Citi believes the Federal Reserve could be forced to cut interest rates further than the market currently expects to support the economy.
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