Markets Overly Optimistic About Fed Rate Cuts, Warns JPMorgan Asset Management

Financial markets may be overly optimistic about the timing and extent of interest rate cuts by the U.S. Federal Reserve (Fed) this year, according to JPMorgan Asset Management. Despite expectations of lower rates due to receding inflation and hints from the Fed about a pivot to rate cuts, critical areas of inflation closely monitored by the central bank have yet to show significant signs of disinflation.

The Fed funds futures market indicates that traders are anticipating 140 basis points of rate cuts this year, almost double the amount projected by the Fed’s interest-rate projections chart in December. However, JPMorgan Asset Management’s macro strategy team, led by Shrenick Shah, believes that the market may be too optimistic and that there is limited evidence of disinflation in certain areas that are of concern to the Fed, such as core services inflation and wage data.

The team also highlights the continued resilience in U.S. economic growth, which could hinder the disinflation process or even create upward pressure. They argue that the Fed’s commitment to combating a potential rebound in inflation is underappreciated, leaving room for a correction in risk assets.

The Fed is set to publish its first rate review of the year later in the day, and it is expected to keep the benchmark interest rate steady between 5.25% and 5.5%. The central bank is likely to push back against heightened dovish expectations, considering the renewed risks of inflation.

The strategists at JPMorgan Asset Management believe that the market is underpricing the potential scenario of rising inflation and that if this is acknowledged, it could trigger a correction in risk assets and support bond yields. They also note that historically, Bitcoin has moved in line with stocks and has been influenced by hawkish Fed developments. The cryptocurrency’s fourth-quarter surge of 57% was partly fueled by expectations of rate cuts and weakness in the U.S. dollar index.

While the strategists believe that the Fed will be ready to defend any emerging weakness in the economy, they also emphasize the central bank’s commitment to combating inflation and its willingness to act if inflation were to rise again.

In conclusion, JPMorgan Asset Management warns that markets may be too optimistic about the Fed’s rate-cutting plans, as critical data on disinflation has yet to materialize. The Fed’s commitment to combating inflation is underappreciated, and if inflation were to rise again, it could lead to a correction in risk assets and support bond yields.