UBS Expects Fed to Signal Rate Cut by Year-End, Citing Two Key Factors

With the new Fed Chair, John Walsh, taking office, market attention is focused on the future direction of US monetary policy. UBS stated that while the market anticipates the Fed might raise rates, considering inflation expectations and labor market conditions, the Fed has no reason to hike and is expected to signal a rate cut by the end of the year.

During an online media briefing on the "Asia FX Outlook," Teck Leng Tan, Head of FX for Asia Pacific at the UBS Chief Investment Office, noted that while the interest rate futures market prices in one to two rate hikes by the Fed over the next year, UBS believes the Fed will not raise rates based on two key observations.

First, regarding inflation expectations, Tan acknowledged that US inflation is indeed high due to elevated energy prices, but he expects it to gradually decline over the next 6 to 12 months. He emphasized that the Fed focuses on medium- to long-term inflation expectations, which remain between 2.5% and 2.7%.

Second, Tan pointed to the labor market, which he said is not as strong as perceived. The US unemployment rate has been between 4.3% and 4.5% over the past six months, slightly above the Fed's estimated long-term equilibrium rate of 4.2%. A recent report on US job openings showed 7.6 million vacancies, higher than expected and exceeding the 7.3 million unemployed persons. However, Tan expressed concern that the hiring rate is only 3.5%, a very low level, indicating that companies are struggling to find workers with the right skills. Furthermore, the quit rate is only 1.9%, reflecting that few people are willing to voluntarily leave their jobs for new opportunities, suggesting the job market is not as robust as it appears on the surface. From a labor market perspective, Tan argued there is no reason for the Fed to raise rates.

Considering these factors, Tan expects the Fed to signal another rate cut before the end of the year, leading to a gradual weakening of the strong US dollar. He forecasts that when market expectations shift from rate hikes to rate cuts, the dollar could depreciate by approximately 3% from its current level.