Deutsche Bank: Under the baseline scenario, the Fed cut interest rates for the first time in June and cut 175 basis points for the whole year

Overnight, the Federal Reserve released the minutes of its blockbuster December meeting, which showed that the Fed believes that the risk of upward inflation has decreased, and expects that the next year may be suitable for interest rate cuts, but provides little information on the prospect of rate cuts.

In fact, there is a general consensus that the Fed will cut interest rates in 2024, but the exact path is still murky. In its latest report released this week, Deutsche Bank noted that the dovish stance at the Fed's December FOMC meeting suggests that there could be a considerable reaction to falling inflation in the coming year.

Deutsche Bank outlines three scenarios for this year's rate cut scenario:

Base case: Slowing inflation + mild recession = sharp rate cuts, the Fed will start cutting rates in June, for a total of 175 basis points in 2024.

Faster Inflation Decline, Mild Recession: In a mild recession, inflation will fall faster and the Fed will cut interest rates more aggressively. In this case, a 225 basis point rate cut is expected for the full year.

Accelerating Inflation Pullback, Soft Landing for the Economy: If inflation accelerates and the economy has a "soft landing," the Fed may start cutting interest rates in March, but only by 100-125 basis points in 2024.

Base scenario: First rate cut in June, first 50 basis point cut, 175 basis point cut for the whole year

Deutsche Bank noted that in the short term, seeing a moderate stabilization trend in core PCE inflation could lead to a multi-month reading of around 0.3% month-on-month, while expecting a mild recession could lead to a slightly higher unemployment rate than consensus and Fed expectations.

In this economic situation, Deutsche Bank expects the Fed to start cutting rates in June, with a total of 175 basis points expected, bringing the federal funds rate down to 3.6%, slightly higher than expectations for the nominal neutral rate. In addition, Deutsche Bank expects the Fed to cut rates by another 50 basis points in early 2025, bringing the policy rate in line with the nominal neutral rate.

In this baseline scenario, several key factors need to be met:

First, core inflation has stabilized in the near term, setting the stage for the Fed to cut interest rates in early 2024.

Second, a mild recession leads to higher unemployment and lower inflation, and once this becomes apparent, the Fed can cut interest rates more aggressively;

Thirdly, the Fed will resolutely not repeat the mistake of the 70s of the last century, that is, to avoid premature rate cuts, which will lead to a delay in the response to the economic slowdown.

Fourth, nominal neutral rates are in the range of 3-3.5%, and a mild recession does not require a significant reduction in interest rates to significantly accommodative levels.

Two off-baseline scenarios: a faster decline in inflation, a "soft landing" for the economy

At the same time, given the uncertainty of subsequent economic data and dovish signals from the Fed, Deutsche Bank proposed two off-benchmark path for rate cuts.

Deutsche Bank noted that, firstly, core inflation will continue to slow in both scenarios, providing evidence that "inflation is likely to be fully under control" for the Fed.

For example, at the March FOMC meeting, the Fed will release PCE inflation data for January, as well as data such as CPI and PPI for February. Under the baseline scenario, core PCE is expected to grow 2.9% year-on-year in January and 2.7% year-on-year in February. In other cases, inflation will be about 20-30 basis points lower, at 2.6% and 2.5%, respectively.

The difference is that a mild recession could allow the Fed to cut interest rates earlier and more aggressively, while in a soft landing, economic growth and labor force remain resilient and the unemployment rate remains around 4%.

Specifically, Deutsche Bank points out that the growth scenarios in these two scenarios are:

Mild recession: The Fed is likely to cut rates sooner, and if the economy and labor markets are weaker than baseline projections, and the path becomes apparent in the second quarter, then the Fed could cut rates by 50 basis points in May, in which case the Fed will cut rates by 225 basis points for the full year, 50 basis points more than the current benchmark expectation, and the policy rate will reach nominal neutral by the end of the year.

Soft landing: The economy is still on a soft landing trajectory and the Fed is expected to start cutting rates by 25 basis points in March, motivated by a faster-than-expected decline in inflation to ensure policy doesn't become too restrictive, and then move to quarterly rate cuts, 100-125 basis points for the whole of 2024, 50-75 basis points less than the current benchmark rate.

This article is from Wall Street News, welcome to download the APP to see more