Will the Federal Reserve cut interest rates within the year?

Since March of last year, the Federal Reserve has put an end to the four-year era of zero interest rates, signaling a path of rate hikes and implementing consecutive increases for over a year.

However, in the May monetary policy statement, the Federal Reserve removed a key sentence from its previous statement, which mentioned that “the Committee anticipates that it may be appropriate to raise the target range at some point.” Based on this, the market widely expects the Federal Reserve to pause its rate hikes at the June meeting. As the rate hike is in line with market expectations and has reached the previously indicated terminal rate for 2023, the market anticipates an end to the more than a year-long rate hike cycle. Moreover, with the recent banking issues following the sudden collapse of Silicon Valley Bank, market expectations for a potential rate cut by the Federal Reserve have resurfaced.

According to a research report by CITIC Securities, both the asset and liability sides of the US banking industry are facing significant pressure. Continuous deposit outflows are expected to further increase the operational and liquidity pressures for banks. Additionally, there are substantial risks associated with commercial real estate loans and unrealized losses from securities investments. However, considering the healthier development of the US financial market since the 2008 financial crisis and the regulatory agencies' increased experience, the probability of systemic risks in the US banking industry is relatively low. Nevertheless, the widespread pressure on banks may accelerate credit tightening, potentially leading to a weakening labor market in the future. Therefore, there is a probability that the Federal Reserve will lower interest rates within this year.

CITIC Securities believes that against the backdrop of deposit outflows and weakened deposit generation capacity, concerns arise regarding the extent of credit tightening in the US, which could gradually manifest negative effects on the economy. It is expected that the pressure on the US banking industry will persist, and the probability of the Federal Reserve refraining from further rate hikes after June is high. The credit tightening may lead to a rapid weakening of the labor market, with the three-month average of non-farm payroll employment potentially declining to around 100,000 by the fourth quarter of this year. Consequently, there is a probability of the Federal Reserve lowering interest rates within this year, possibly in the fourth quarter or the first quarter of next year.

Federal Reserve Governor Kashkari recently warned that although the most severe period of stress in the banking industry seems to have passed, it is still premature to declare all issues resolved. Historical patterns indicate that the possibility of further problems cannot be ruled out. However, Kashkari acknowledged that the actions taken by the Federal Reserve and other regulatory agencies have curbed the surge in banking issues witnessed in March. With the easing of current price pressures and significant uncertainty regarding how the credit tightening resulting from the March banking crisis will impact the outlook, many Fed officials have hinted at the need to pause rate hikes and assess the economy's response to recent events. Kashkari supports a pause in rate hikes but stated, “I don't want to declare victory” in completing the rate-hiking cycle, as future data may warrant further increases.

However, a survey conducted by the National Association for Business Economics (NABE) revealed that economists now expect the Federal Reserve to lower its target policy rate in the first quarter of next year. In the previous survey conducted in February, respondents anticipated a rate cut in the fourth quarter of this year. The surveyed economists have also revised their inflation expectations for 2023, with the current forecast at 3.3%, higher than the previous survey's projection of 3%.