Citigroup, $C, expects the US Federal Reserve to start cutting interest rates in July versus June expected earlier

Citigroup, $C, expects the US Federal Reserve to start cutting interest rates in July versus June expected earlier.

Economists at Citigroup Inc. are taking a contrarian stance, disagreeing with the prevailing sentiment on Wall Street regarding the Federal Reserve's actions.

Despite recent inflation readings coming in slightly higher than expected for three consecutive months, other major banks like Bank of America Corp., Goldman Sachs Group, and Morgan Stanley have revised their forecasts for interest-rate cuts this year. Federal Reserve Chair Jerome Powell also indicated on Tuesday that policymakers are not in a rush to ease policy, supporting these revised forecasts.

However, Andrew Hollenhorst and Veronica Clark of Citigroup believe that this rush to judgment is misguided. They argue that the Fed is still concerned about the possibility of the strong economic growth seen recently coming to a halt. As a result, they are maintaining their forecast for five quarter-point rate cuts this year, suggesting that policymakers are ready to act on any signs of disinflation or economic weakness.

Hollenhorst, who has consistently included sticky inflation expectations in his estimates, explained their view, saying, “We think the Fed’s reaction function is a lot more dovish than the consensus.”

This outlook from Citigroup is in contrast to the broader sentiment in financial markets, where bond yields rose after last week’s consumer price index report led investors to adjust their expectations. Derivatives markets are pricing in only about a 10% chance of a rate cut in June and are skeptical about the Fed enacting two quarter-point reductions this year.

However, financial markets have struggled to accurately predict the Fed's actions in recent years, often underestimating both the extent of tightening and the timing of policy reversals. If Citigroup's economists are correct, this latest turn may be another case of misjudgment by the markets.

Central to Citigroup's view is the upcoming data on the core personal consumption expenditures index, a key inflation measure favored by the Fed. They anticipate that it will show a moderation in price pressures. If the index shows monthly gains similar to those seen in February, around 0.25% in March and April, the Fed may feel justified in beginning to lower policy rates gradually starting in June or July, according to the economists.

Additionally, Citigroup expects that the Fed will prioritize any signs of economic weakness, such as a slowdown in the job market, over data indicating continued strength. They believe there is a bias within the Fed toward easing policy, which will influence their decisions.