Citi Predicts Fed to Cut Rates by 200 Basis Points Amid Economic Slowdown

Citi Research analysts predict the Federal Reserve will implement eight consecutive 25 basis point rate cuts starting in September, in response to signs of economic slowdown. The expected reductions would lower the benchmark rate by 200 basis points by July 2025.

Citi Research Predicts Federal Reserve to Implement Eight Consecutive Rate Cuts Starting in September

Analysts at Citi Research anticipate that the Federal Reserve will implement a series of rate reductions that will commence shortly and continue until the following year's summer, according to Fortune,

The bank's assessment that the Federal Reserve will reduce rates by 25 basis points eight times, commencing in September and continuing until July 2025, was supported by recent indications of an economic slowdown in a note issued on July 5.

The note stated that the benchmark rate will be reduced by a significant 200 basis points, or from 5.25%-5.5% to 3.25%-3.5%, where it will remain for the remainder of 2025.

Citi analysts, led by chief U.S. economist Andrew Hollenhorst, have reported that the economy has cooled from its "heady" pace in 2023, with inflation resuming decelerating after some unexpected stickiness.

However, the risk of a more severe decline in economic activity and a faster tempo of rate cuts has been increased by the Institute for Supply Management's service-sector gauge, which abruptly reversed into negative territory, and the monthly jobs report showed unemployment rising to 4.1%. Additionally, they noted.

The data, in conjunction with Fed Chair Jerome Powell's dovish remarks on July 2, indicate that the initial rate cut will likely occur in September.

“A continued softening of activity will provoke cuts at each of the subsequent seven Fed meetings, in our base case,” Citi predicted.

Citi Warns of Economic Vulnerabilities, Predicts Potential Activation of Sahm Rule Recession Indicator

Additionally, the note identified additional indicators of vulnerability in the employment report. The prior months were revised downward even though the headline payroll gain of 206,000 appears to be substantial. In June, 49,000 temporary services positions decreased, which Citi characterizes as "the type of decline that is typically seen around recessions as employers begin to reduce labor with the least strongly attached workers."

It also stated that the unemployment rate derived from a distinct survey is the more significant metric, as payroll data are likely skewed to the upside. In that regard, Citi cited the "Sahm Rule" recession indicator and predicted that it could be activated in August if unemployment continues to increase at its present rate.

Hollenhorst has maintained a dimmer perspective on the economy this year despite the Wall Street consensus transitioning to a gentle landing, making him a relative contrarian.

In May, he reiterated that the United States is on the brink of a harsh landing and that Fed rate cuts would be insufficient to avert it. A comparable forecast was issued in February despite numerous job announcements that exceeded expectations.

In a July 3 interview with Bloomberg TV, Hollenhorst stated that a severe recession would likely result in a sufficient political consensus to increase government spending to stimulate the economy, thereby resolving concerns regarding the substantial deficit. However, he also noted that a less severe recession may not lead to a consensus.

He also noted that rate cuts have stimulated the economy less than anticipated, just as Fed rate increases slowed the economy less than expected. In addition, the 10-year bond yields, which are used as benchmarks for a wide range of borrowing costs, are already lower than the 2-year yields. This means there is less space for further downside, particularly as inflation and rising deficits add upward pressure.

“Most economic activity is going to be more responsive to a 5-year yield, the 10-year yield. It’s not really about the overnight policy rate,” Hollenhorst explained. “So there really are questions about how much can you transmit that stimulative effect of lower policy rates.”

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