Goldman Sachs acknowledges "Expected three rate cuts this year": Rate cuts are optional for the Federal Reserve, not mandatory

The expansion of the manufacturing industry, the unexpected surge in March non-farm payroll employment numbers, and the decline in the unemployment rate all indicate that the labor market remains active, seemingly supporting the view that the "Fed is not in a hurry to cut interest rates".

On April 8th, Goldman Sachs analyst Rikin Shah released a report stating that the U.S. added 303,000 non-farm jobs in March, the largest increase since May last year, exceeding all analysts' expectations. In the past 12 non-farm reports, 9 have exceeded expectations, indicating that the labor market is quite resilient, implying that Fed rate cuts are "optional" rather than "mandatory".

Rikin Shah believes that the current average monthly non-farm job growth rate over the past 3 months has reached 276,000, leading to an expected year-on-year GDP growth rate of 2.5% in the fourth quarter of 2024, higher than the consensus. There are almost no signs at present that rate cuts are necessary.

However, Goldman Sachs Chief Economist Jan Hatzius remains optimistic about the Fed's rate cut expectations. After the release of the non-farm report last Friday, he still expects the Fed to cut rates three times this year. If the Fed ultimately decides that there is absolutely no need to cut rates, he would be "very surprised".

Since the beginning of this year, Wall Street's expectations for the number of rate cuts by the Fed this year have continued to decline, from 7 cuts to 3 cuts, and now this number may further decrease.

CME's FedWatch Tool shows that the market's expectation of the Fed's first rate cut in June has dropped from 55.2% a week ago to 50.8%. If this week's U.S. March CPI data exceeds expectations again, the likelihood of a "first cut in June" may fall below 50%.

Market Conditions Remain Loose

Goldman Sachs analyst Rikin Shah pointed out that in recent weeks, due to strong data, forward rates in the middle of the yield curve have steadily risen, and the market is gradually starting to price in higher terminal and neutral rates, with the market now expecting a 3.8% rate for the next 5 years, which is relatively high.

At the same time, Goldman Sachs noted that the Financial Conditions Index (FCIs) has not tightened, with the 5-year forward rate trading range not far from the range during the FCI tightening period last autumn:

The reason why the FCI has not tightened is mainly because risk assets continue to perform well. The market's continued postponement of the Fed's rate cut expectations is being driven by improved economic prospects, as well as the positive impact of artificial intelligence (AI) on the stock market. The market's optimistic expectations for the economy outweigh concerns about the negative impact of potential rate hikes. Rikin Shah pointed out that if the market's expectations for a rate cut by the Federal Reserve continue to decline and US Treasury yields rise, there remains uncertainty about whether the financial conditions index will tighten. If there is excessive volatility in US Treasuries, with a sharp decline, it could potentially have a negative impact on risk assets, leading to a tightening of the financial conditions index:

Currently, we believe that this scenario is unlikely to happen immediately, but there are some risks in the second half of the year, which may lead to this change during the election period and with the continued presence of economic deficits. Although some views suggest that there is a possibility of a US economic recession if the Federal Reserve does not cut rates, the probability of this happening is currently low (GIR recession probability is only 15%).

The Federal Reserve Appears to Be "Increasingly Hawkish"

With several Federal Reserve officials adopting a hawkish stance, coupled with strong non-farm payroll data, more and more economists on Wall Street are starting to predict that there may not be any rate cuts this year.

In recent days, several senior Federal Reserve officials have made speeches, with many expressing hawkish views. Following Minneapolis Fed President Kashkari's statement on Thursday that the Fed may not cut rates this year, Federal Reserve Governor Bowman, who has permanent voting rights on the FOMC, said on Friday that it may be necessary to raise rates to control inflation.

Bowman stated that there are some potential upside risks to US inflation, and policymakers need to be cautious not to loosen monetary policy too quickly. It may even be necessary to raise rates to control inflation.

Regarding the discussion of raising rates, Bowman stated that although this is not her baseline expectation, she still believes that if inflation stagnates or reverses, the Fed may need to further raise policy rates at future meetings. Bowman stated that the most likely outcome is still that the Fed will eventually lower rates.

Bowman explicitly stated that it is not yet time to cut rates, as there are still some upside risks to inflation. Lowering policy rates too early or too quickly could lead to an inflation rebound. Looking ahead, it may be necessary to further raise policy rates to restore the inflation rate to 2%.

Ed Yardeni, President and Chief Investment Strategist at investment firm Yardeni Research, pointed out in a report that investors may finally be considering the possibility of no rate cuts by the Federal Reserve this year. The recent rise in oil prices indicates that inflation still faces upside risks