Citi's Expectations on Fed Rate Cuts

Citi strategists anticipate that the Federal Reserve will reduce rates by 50 basis points (bps). They believe that the upcoming October inflation data is unlikely to alter the reflation narrative.

Markets are expected to receive updated October inflation metrics soon, including the Consumer Price Index (CPI) set to be released on Wednesday, along with reports on wholesale inflation and retail sales.

Recently, market sentiment has shifted back to concerns over rising inflation, limiting the possibility of Federal Reserve rate cuts. As a result, CPI data is now seen as almost as critical as employment data for guiding the Fed’s decisions.

Strategists Veronica Clark and Andrew Hollenhorst noted, "We continue to think overall slowing inflation and a weakening labor market will have Fed officials cutting rates more over the next 6-9 months than the market currently expects."

They project a core CPI increase of roughly 0.26% month-over-month for October. They caution that another rise of 0.3% in core CPI could heighten inflation fears. However, they also believe factors such as high used car prices, health insurance, and easing shelter inflation could support the idea of declining underlying inflation trends.

Citi estimates a growth of 0.24% month-over-month for core PCE inflation in October, influenced by strong recent PPI data.

If inflation figures are stronger than expected, following a 0.25% rise in core PCE for September, it might cause markets to lower the odds of a rate cut in December. Nevertheless, Citi's analysts note that the anticipation of stronger inflation has already been priced into the market, and volatility in certain components could present underestimated risks to the downside.

In their opinion, weaker inflation and employment data in November will likely trigger at least a 25 basis point cut in December, with a base-case scenario pointing towards a 50 basis point cut.

Citi's forecast for a 0.26% month-over-month core CPI increase is influenced by factors including a 0.16% rise in core goods prices, a 0.32% increase in shelter prices, and a 0.26% growth in core services prices excluding shelter, which is milder than the previous month.

For overall headline CPI, they project a 0.2% month-over-month rise and a 2.6% yearly increase, reflecting decreased energy prices. They also see potential downside risks within the food away from home segment, which may impact core PCE inflation.