Source: Zhitong Finance

Tom Lee (Tom Lee), head of research at Fundstrat, a well-known market analyst, predicts that the Federal Reserve is expected to cut interest rates for the first time this year in less than two months, based on the latest inflation indicators and market trends. Li previously accurately predicted a 20% increase in the stock market last year. He put forward his views in a video for Fundstrat customers. He believes that inflation in the current economy is slowing down.

Lee's views are mainly based on three gentle signals. The first is the personal consumption expenditure (PCE) index, which is the Federal Reserve's favorite measure of inflation. It rose 2.8% year over year in February, the slowest growth rate in three years. Second, consumer inflation expectations are also “falling sharply”. According to the University of Michigan's latest survey, the median one-year inflation forecast for February remained around 3%.

Mr. Lee also pointed out France's core inflation figures — the first inflation data released in the global economy in March. According to the data, inflation in France fell from 0.9% to 0.2% last month, which may indicate that inflation in most economies will also decline, especially considering that the January and February inflation data may be a “statistical anomaly.”

All of these factors suggest that the Federal Reserve may cut interest rates earlier than the market expected, which is good news for the stock market.

The market reaction was not that optimistic

Although traders have been waiting for the Fed to cut interest rates for over a year, according to data from the CME FedWatch tool, the market only gave the possibility that the Fed would cut interest rates by 75 basis points or more this year, which is down from the 85% forecast a month ago. Meanwhile, only 57% of investors expect the Federal Reserve to cut interest rates for the first time in June.

According to a report released recently, US factory orders in February increased 1.4% month-on-month, a new high since November 2023. JoLTS vacancies in the US increased by 8.756 million in February, the smallest increase since October 2023. The US manufacturing and job market both showed strong momentum, which supports the assertion that the resilience of the US economy continues to increase throughout the year.

Furthermore, the latest data, combined with continued high inflation and signs of rising commodity prices such as oil, has further reduced expectations of the Federal Reserve's monetary easing policy and prepared for interest rates to continue to rise over a long period of time.

Currently, investors expect to cut interest rates by about 65 basis points in 2024, while the median forecast announced by the Federal Reserve after the March meeting is 75 basis points. This is a shift from what happened in recent months, when traders' predictions were more dovish than the Federal Reserve's predictions.

Furthermore, in the past week, the most active SOFR options trade was the option with an exercise price of 95.00, which extends until December 2024. Tuesday's deal included the purchase of a “butterfly” call option portfolio with strike prices of 95.00, 95.25, and 95.50 in September 2024, respectively. This indicates that investors expect interest rates to be lowered by about 50 basis points by the time of the September policy meeting.

Of the SOFR options with an exercise period up to December 2024, options with an exercise price of 95.50 (target yield of 4.5%) received the most attention, especially call options and put options for June, September, and December 2024. Other notable strike prices include 95.00, 95.25, and 94.875. Among them, the June 2024 call and put options also had a high concentration of trading.

These SOFR options market data indicate that investors expect the Federal Reserve may cut interest rates at some point in 2024, especially around specific points in June, September, and December.

In response, Li pointed out that this may be because the market is concerned about manufacturing prices and the ISM price index rose to 55.8% in March, which is the only indicator of bullish inflation in the past two trading days.

He said, “I think this is an illusion. Further verification will appear on April 10, when the Consumer Price Index report for March will be published. Our basic judgment remains that inflation is falling sharply.”

FOMC voting committee and economists remain cautious

On Tuesday, Cleveland Federal Reserve Chairman Mester and San Francisco Federal Reserve Chairman Daly also spoke on inflation and the Federal Reserve's monetary policy. They both emphasized the importance of adjusting monetary policy based on actual economic data.

Among them, Meester said that she still expects the central bank to be able to cut interest rates this year, and pointed out that if the data allows, June will be the beginning of interest rate cuts.

Mester said, “If the economy develops as expected, then in my opinion, it would be appropriate to start lowering the federal funds rate later this year as inflation continues to move down the path of 2% while the labor market and economic growth remain stable.”

As for the pace of this action, she pointed out that if the economy meets expectations, it may proceed “gradually.”

Meester warned that in order to pave the way for the relaxation of monetary policy positions, she needed to see upcoming inflation data in line with her predictions for a further decline.

In her speech, Meester pointed out that monetary policy is currently in a good position because a strong economy gives the central bank room to collect data before making changes in interest rates. She expects inflation to continue to fall, albeit at a slower pace than last year. She also warned against cutting interest rates too soon.

“Lowering interest rates too soon or too fast will risk offsetting our progress in inflation until there is not enough evidence to convince us that inflation is returning to 2% on a sustainable and timely path,” Meester said. “At this point, I think it would be more risky to start lowering fund interest rates too soon.”

Furthermore, San Francisco Federal Reserve Chairman Daly said that even if inflation is still higher than the Federal Reserve's target, it is time to pay more attention to the risk of keeping interest rates high for a long time.

Daly pointed out that in order for the Federal Reserve to lower interest rates, more progress is needed to reduce inflation, but officials need to be careful not to keep monetary policy restrictive for too long, thereby risking damage to economic growth or the labor market. This emphasizes the Federal Reserve's dual mission of ensuring price stability and maximum employment.

“We (as policy makers) have a responsibility to do what we can to create a lasting expansion,” Daly said during a speech in Las Vegas. “Because if we experience a recession, of course inflation will fall faster, but jobs will be lost... (many people) will experience lower inflation, but no jobs.”

“Predictions are not promises,” Daly said. You have to stay prepared... what if inflation is harder to fall than I predicted? We might want fewer cuts... what if the labor market starts to falter or inflation falls faster? Then we might need to cut even more.”

Meanwhile, some economists warn that the risk of inflation may remain high for longer due to continued price pressure in the economy. Top economist Mohammed El-Erian recently warned that given that the underlying inflation rate associated with a strong economy may have risen in recent years, the Federal Reserve should wait “a few years” before starting to cut interest rates.

Editor/Somer