Will there be no interest rate cut this year? Maybe even a rate hike? Will the Federal Reserve be embarrassed again?

In January, two major inflation data, CPI and PPI, in the United States exceeded expectations, with service inflation reigniting. Federal Reserve officials' "tough stance" has led to continuous market adjustments in interest rate expectations. Now, an even more extreme situation has emerged, with former U.S. Treasury Secretary Summers and several Wall Street investment banks calling for "rate hikes" one after another. Are investors going to be proven wrong again this year?

Over the past two years, the financial markets have seen several "false dawns." Investors accustomed to a prolonged era of loose monetary policy have been predicting that the Federal Reserve will "shift," only to be proven wrong time and time again. However, since December last year, when Federal Reserve Chairman Powell suddenly changed course, Wall Street has once again heavily bet on an imminent rate cut.

However, the recent monetary policy of the Federal Reserve has put pressure on the economy, while the "anti-inflation" process has unexpectedly hit a bump. On February 16th, as a whistleblower for high inflation in the United States, Summers bluntly stated in an interview that the next step for the Federal Reserve is likely to be a rate hike, not a rate cut, with a 15% probability. He believes that the Federal Reserve's actions must be "very cautious."

Not only Summers, but several Wall Street investment banks are also warning investors of the risks of a Federal Reserve rate hike. Analyst Kit Juckes from French bank Societe Generale believes that the Federal Reserve has "no reason to rush" to cut rates. If the U.S. economy accelerates growth again, the next interest rate decision by the Federal Reserve may be a hike rather than a cut.

Mark Nash, a macro fund manager at the UK asset management giant Jupiter Asset Management, believes that there is a 20% chance of the Federal Reserve raising rates instead of cutting them. He thinks that strong consumer demand and the prospect of companies increasing spending could exacerbate inflation risks:

"If there is a large demand for capital, spending is also high, and inflation is above target, the Federal Reserve will have to further raise interest rates," he said. "This is not a huge risk, but it should not be ignored."

In a research report last week, the U.S. economic team at Deutsche Bank proposed that compared to the FOMC's forecasts, the U.S. economy may face a lower unemployment rate and a slower cooling of inflation in the future, which may lead the Federal Reserve to keep rates unchanged this year, with a not insignificant probability of this outcome occurring.

Market Continuously Postpones Rate Cut Expectations

Since the beginning of this year, the bet on a Federal Reserve rate cut has been a key focus for Wall Street investment banks' strategies.

In December last year, when Federal Reserve Chairman Powell suddenly changed course, traders once again began betting heavily on a significant rate cut by the Federal Reserve. Starting as early as March, the rate cut could be as high as 175 basis points, a significant difference from the Fed's implied three rate cuts of 25 basis points each.

However, due to recent data showing ongoing twists and turns in U.S. "de-inflation," and the U.S. economy still appearing resilient, market expectations for the Federal Reserve's rate cut timetable have been continuously pushed back.

Currently, Federal Reserve observation tools show that the market expects the first rate cut by the Federal Reserve to be more likely to occur in June, with a probability of 53.7%; while the likelihood of a rate cut in March has dropped from around 55% a month ago to 10%, with a high 90% probability of maintaining rates unchanged in March. The Federal Reserve will face the market again?

On one hand, the road to future inflation resistance in the United States is bumpy. In January, the CPI in the United States increased by 3.1% year-on-year, and the PPI increased by 0.9% year-on-year, both higher than market expectations. Sammers pointed out that the current idea of a "soft landing" for the U.S. economy is under threat when mentioning these two major inflation indicators.

Structurally, the root cause of the resistance to the downward trend of core inflation in January lies in core services. The year-on-year core service inflation in January was 5.4%, up 0.1 percentage point from December 2023, and up 0.3 percentage point month-on-month to 0.7%. Core service inflation has become a key factor hindering the decline in core inflation.

The most important reason is rental inflation. In January, the year-on-year main residential rent and owner's equivalent rent continued to decline; however, the main residential rent inflation remained flat month-on-month at 0.4%, and the owner's equivalent rent inflation expanded to 0.6% month-on-month, reaching a high point since April 2023.

Sammers stated that for some time, economists' main expectation has been that housing costs will become an important factor in lowering inflation in the overall price index. However, this has not yet materialized. At the same time, there is also significant inflation pressure on services other than housing. The month-on-month inflation of services other than housing in January was 0.6%, the highest since September 2022. Sammers believes that the "de-inflation" path in 2024 will still face challenges.

Sammers pointed out that in the case where inflation remains a problem, the Federal Reserve will not be willing to risk relaxing its policies too early. He metaphorically said:

"When a doctor prescribes antibiotics for you, the worst thing you can do is to only accept partial antibiotic treatment, and stop using them once you feel better. It is often because you dislike taking medication and give up antibiotic treatment prematurely that your illness tends to relapse, and it is often more difficult to recover after a relapse."

On the other hand, the U.S. economy and labor market still seem resilient. The January non-farm payroll report showed a significant increase in employment numbers beyond expectations, indicating that the labor market remains hot and economic growth momentum is strong. Previously, a series of economic data, including the GDP growth rate in the United States in 2023, also contradicted the claim that "the U.S. economy is quickly entering a recession."

Kit Juckes wrote in the report that if the U.S. economy accelerates again, the Federal Reserve will eventually have to raise interest rates again, and the U.S. dollar will rise:

Even though the current market prices the possibility of a rate hike at zero, the risk of a rate hike is beginning to spread. If the Federal Reserve raises interest rates again, the U.S. dollar index is expected to approach its historical high. In addition, analysts have pointed out that the market always anticipates the Federal Reserve's moves in advance. Jawad Mian, the founder of Stray Reflections, a macro consulting firm collaborated by global hedge funds and portfolio managers, highlighted in a report that back in 2008-2009, to combat economic recession, the Federal Reserve lowered the federal funds rate to near-zero levels. However, the market early on anticipated the Fed to start raising rates. This ultra-low interest rate environment persisted for a long time until December 2015 when the Fed finally began to raise rates, marking the first rate hike since the financial crisis.