Wall Street Adjusts Expectations for Federal Reserve Rate Cuts as Caution Prevails

Wall Street has adjusted its stance on aggressive Federal Reserve rate cuts, reflecting investor beliefs that the central bank will adopt a more cautious approach in its tightening cycle.

According to the CME’s FedWatch tool, the probability of a 50 basis point rate cut by year-end has decreased from 50% to 30% since early May. Conversely, the likelihood of a 25 basis point cut has risen from 50% to 70%.

This shift in expectations is driven by rising investor concerns over the impact of inflation on the economy. In May, the Consumer Price Index recorded an 8.6% increase, marking the highest inflation rate in 40 years.

Although the Fed is anticipated to raise interest rates by 50 basis points at its upcoming meeting on June 14-15, investors are now speculating that the central bank will pause its tightening cycle thereafter to assess the economy’s response.

The Fed faces a delicate balancing act as it aims to mitigate inflation while avoiding the risk of triggering a recession. Raising interest rates too swiftly could result in a sharp economic slowdown, while insufficient rate increases may allow inflation to spiral out of control.

As it strives to avert a recession, the Fed is likely to maintain a cautious approach in its tightening cycle. However, the central bank must also be prepared to adopt a more aggressive stance if inflation continues to escalate.

Several factors have contributed to the decline in expectations for aggressive Fed rate cuts:

1. Economic growth slowdown: The US economy expanded at a rate of 1.5% in Q1, the slowest pace in a year.
2. Decrease in inflation expectations: The 10-year breakeven inflation rate, reflecting the market’s inflation expectations for the next decade, has declined from 3.2% to 2.9% since early May.
3. Strength of the US dollar: The US dollar has strengthened against major currencies in recent months, potentially curbing inflationary pressures.

While the diminishing expectations for aggressive rate cuts bode well for the stock market, investors should exercise caution as the Fed navigates the complexities of its tightening cycle.