Traders bet on aggressive rate cuts by the Fed, Deutsche Bank strategist: They keep making the same mistakes over and over again
Traders are betting that the Federal Reserve will actively cut interest rates, but Deutsche Bank strategists believe they may be wrong again. Traders expect a 175 basis point rate cut over the next 18 months, the highest expectation since early March. Deutsche Bank strategists point out that the Federal Reserve is unlikely to cut rates by such a large margin unless the U.S. economy contracts. Investors are looking for more guidance on rate cuts from the Fed chairman this week. The market has shifted towards small-cap stocks, while tech stocks have seen some pullback
From now until the end of next year, traders are betting that the Federal Reserve will actively cut interest rates, but it seems they may be wrong again.
According to information from the Wise Finance APP, based on an email comment from Deutsche Bank strategist Jim Reid, traders are expecting a 175 basis point rate cut over the next 18 months, the highest expectation since early March. Reid pointed out that apart from one instance in the mid-1980s when real interest rates were still very high, the Fed only cuts rates significantly when the U.S. economy is contracting.
While an economic recession before the end of next year is not impossible, recent data shows only mild signs of cooling in the economy and labor market. Reid believes that traders' actions may stem from an "inherent dovish interest rate bias" rather than foreseeing an economic downturn. Since the Fed began raising borrowing costs in March 2022, this is the eighth time Reid has calculated traders' aggressive rate cut predictions, only to eventually overturn them.
Reid also outlined two scenarios that could lead to seven rate cuts by the Fed over the next 18 months. One is if the U.S. economy enters a recession by the end of 2025; the other is the uniqueness of the post-COVID era economy, allowing the Fed to significantly lower borrowing costs without triggering inflation even without a recession. The latter scenario would be a "perfect soft landing," although technically possible, Reid believes it is unlikely.
Investors are hoping that Fed Chair Powell will provide more guidance on the central bank's rate cut plans later this week, as traders are almost certain that rate cuts will begin in September. Powell's hinting at a rate cut in September could have a significant impact on the market. Since the June inflation report came in lower than expected, the market has shifted towards small-cap stocks, while tech giants and semiconductor stocks have seen some pullback.
According to FactSet data, in July, the iShares Russell 2000 ETF rose by 11.7%, while the S&P MidCap 400 Index rose by 10.6%. In comparison, the tech-heavy Nasdaq Composite Index fell by 2.1% during the same period