UBS Predicts Future Fed Rate Cuts with Cautious Outlook

UBS's Forecast on Federal Reserve Rate Cuts

UBS economists are making waves with their prediction that the Federal Reserve will initiate the next interest rate cut come June. They expect this adjustment to be a modest 25 basis points, followed by another similar reduction in September.

Understanding Recent Rate Changes

Just recently, the Fed made headlines by cutting rates by 25 basis points at its Federal Open Market Committee meeting. This decision paralleled market expectations and marked the fourth reduction since the previous September. Consequently, the cumulative cuts amount to 100 basis points, adjusting the policy target range to 4.25%-4.5%.

Hawkish Outlook and Market Reactions

Despite these cuts, the updated dot plot indicated a more hawkish approach than many had envisioned. Currently, the median projection presents only 50 basis points of cuts for 2025, a drastic change from the earlier indications of 100 basis points in the September dot plot. Such forecasts suggest that policy adjustments might continue through to 2027, indicating a longer timeframe for economic recovery.

The market's response to the Fed's announcements was notably negative; equity markets took a hit, bond yields rose, and the dollar experienced a rally.

Fed Chair's Optimistic Stance

During the post-meeting press session, Fed Chair Jerome Powell shared positive insights regarding the economy’s health and the outlook projected for 2025. While acknowledging that economic growth has exceeded the Federal Reserve’s recent outlooks, Powell pointed out that inflation remains stubbornly elevated, far above the desired 2% target. This context implies that the Fed is poised to take a more cautious stance when it comes to enacting further rate cuts.

Adjustments to Rate Forecasts

Brian Rose, a senior economist at UBS, indicated their organization's views align closely with the Fed’s perspective on economic trends. As a result, they've modified their expectations for rate reductions, following the indications from the updated dot plot. UBS now foresees rate cuts of 25 basis points for both the June and September meetings, summing up to a total of 50 basis points anticipated for 2025, a significant decrease from the initially projected quarterly cuts of 100 basis points.

The Potential for March Cuts

Even though the cautious path seems to be the favored approach at present, Rose notes that should there be unfavorable news from the labor market early next year, discussions of a potential rate cut in March could swiftly become relevant again.

The Impact on the Dollar

The Fed's hawkish position led to a significant rally in the U.S. dollar. In fact, the dollar index briefly exceeded 108, reflecting the market's reactions to interest rate trends observed over the last couple of years. This situation is projected to continue influencing the dollar into 2025.

Political Influences on Currency Strength

Political developments, such as Donald Trump’s upcoming inauguration, are expected to support the dollar's position in the near term. However, UBS cautions that the dollar's upward trajectory has its limits, citing concerns about overvaluation, the lack of anticipated easing of U.S. monetary policy in 2025, and the market's spotlight on the favorable attributes of Trump’s administration. Should circumstances deviate from these forecasts, a downturn could quickly ensue.

Future Predictions for Currency Markets

UBS considers the current dollar rallies as optimal selling opportunities. They predict that the EUR/USD will revert to 1.10 later in 2025, aligning expectations with prevailing market conditions.

Frequently Asked Questions

What are the expected rate cuts from the Federal Reserve?

UBS anticipates that the Federal Reserve will implement rate cuts of 25 basis points in June and September, summing up to a total of 50 basis points for 2025.

Why did the markets react negatively to the Fed's announcements?

The market's negative reaction was due to rising bond yields, falling equity prices, and a strengthening dollar following the Fed’s hawkish updates.

How does Fed Chair Jerome Powell view the economy?

Powell conveyed optimism regarding economic growth and indicated that inflation is still above the targeted levels, suggesting a careful approach to future rate adjustments.

What limits the dollar's strength according to UBS?

UBS points to factors such as overvaluation, minimal expectations for U.S. monetary easing in 2025, and the political landscape influencing possible dollar pullbacks.

What is UBS’s prediction for the EUR/USD exchange rate?

UBS predicts that the EUR/USD rate is likely to return to 1.10 later in 2025, echoing their overall market outlook.

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