Federal Reserve Will Only Cut Interest Rates Twice This Year Warns AXA

Above: File image of Fed Chair Powell.

The Federal Reserve is tipped to cut just twice this year and potentially only twice more in 2025, in a prediction that could potentially offer the Dollar a material boost.

AXA Investment Managers say the latest U.S. inflation figures confirm its view that inflation won't sustainably undershoot the Federal Reserve's target on current trends.

"We do not consider inflation to be on track to sustainably undershoot the inflation target. Indeed, we think that the Fed still has a job to do in ensuring a softening in the economy sufficient to achieve a return to target," says David Page, Head of Macro Research at AXA Investment Managers.

The predictions serve as a timely warning to investors who are banking on an aggressive path of interest rate cuts from the Fed in the coming months, with 100 basis points of cuts expected for 2024 alone.

But AXA thinks investors will get just half of this, which, if correct, will require an adjustment in market prices: higher Treasury yields, lower equities and a stronger Dollar.

"We consider the scale of Fed cuts currently priced in by markets as excessive," says Page. "We continue to forecast the Fed will start to lower rates by 0.25% next week and that we will continue to see only one further cut this year in December."

Page's assessment comes after the U.S. reported core inflation read at 0.3% m/m in August, beating consensus expectations of 0.2%.

"The dollar is trading a touch stronger as the August US inflation report appears to have effectively ruled out the possibility of a jumbo interest rate cut from the Federal Reserve this month," says Matthew Ryan, Head of Market Strategy at global financial services firm Ebury.

Regarding next year, AXA thinks the outlook for interest rates will be election dependent, "but stress that a Trump win would likely limit the Fed to two cuts next year if the next administration enacts the demand stimulus and supply restrictive policies Trump suggests."

This adds to the notion that a Trump win would be USD-supportive.

AXA is not a lone voice, as Euro Pacific Asset Management also warns that inflation will disappoint. "We’ve consistently highlighted the persistent undercurrents of inflationary pressures, and the recent data does little to dispel these concerns," says Euro Pacific's Peter Schiff.

The August reading of 2.5% y/y is not as moderate as it first appears, with Schiff warning it masks a more complex and concerning reality beneath the surface:

"The stabilisation of headline inflation largely owes to temporary declines in cyclical commodities and energy prices, which historically tend to fluctuate with seasonal demands. However, as we move into the colder months, there’s a high probability that these sectors will rebound, potentially pushing the headline inflation rate higher."

Schiff warns the implications of these numbers for the financial markets, particularly the bond market, are profound.

"The bond market has been pricing in lower rates, perhaps overly optimistic about the Federal Reserve’s ability to manage inflation through rate cuts. If the Fed does proceed with rate cuts while inflation is rising, this could lead to negative real interest rates, further fueling inflationary expectations," he says.

Such an outcome would derail the market's current risk-on consensus as the Fed could be forced into a strong pivot and raise rates again, "assuming the Fed has the courage to make such a move."

If it does, "this shift could have a very negative impact on asset markets, as higher interest rates often lead to decreased valuations in equities and real estate," says Schiff.