Home Editor's Picks UBS sees high uncertainty over how much the Fed will cut rates this cycle

UBS sees high uncertainty over how much the Fed will cut rates this cycle

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UBS strategists said there is “high uncertainty” surrounding the extent to which the Federal Reserve will cut interest rates in the current cycle. The consensus among investors is leaning towards a soft landing, but there is considerable ambiguity about future Fed actions, particularly in 2025.

Investor views on the economic outlook are converging, contributing to lower volatility in the markets. Both the VIX index, which measures S&P 500 volatility, and the MOVE index for bond market volatility fell in late May to their lowest levels since before the Fed began hiking rates in March 2022.

“These are certainly imperfect measures to quantify the convergence of investor expectations,” UBS strategists wrote. “And one could argue that low volatility is a better indicator of investor complacency rather than convergence on the macro outlook.”

Recent economic data, most notably slowing job growth, continuing disinflation, and Fed downplaying the possibility of rate hikes, have reduced macro risks in May, thereby restoring investor faith in a soft landing.

A key factor behind this convergence of views is the narrowing path for the Fed funds rate this year, along with the policy rates of other major central banks. Currently, the market anticipates approximately 1.5 Fed rate cuts before the end of the year.

Strategists point out, “It’s quite unlikely to be more than two cuts and the fewest is none, which means a small range.”

“Rate volatility should fall if the funds rate is relatively anchored for the time being, which would dampen volatility in other asset classes,” they added.

Looking ahead, UBS believes that at some point during the summer, the focus will shift to 2025, where there is a wider range of possible economic outcomes compared to this year.

“In particular, ambiguity over just how restrictive current Fed policy actually is means there’s high uncertainty over how much the Fed will cut rates this cycle,” said UBS. “Consequently, market calm this summer may be disrupted by a divergence of views on what the Fed will be doing in the summer of 2025.”

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