Citi Research Sees Weaker Case for Aggressive Fed Rate Hikes

Citi Research is questioning if the aggressive rate increases that markets anticipate are actually necessary for the Federal Reserve. The institution maintains this stance despite predicting worldwide headline inflation of 3.5% for the current year.

According to Citi, the Fed's September rate hike was driven by a resilient economy and inflation exceeding its target. But Nathan Sheets, the global chief economist, and his team perceive less justification for further aggressive policy tightening.

How Does Citi Weigh Inflation Against Fed Hikes?

Brent crude oil continues to trade around $105 per barrel, according to Citi. This has driven the bank's global inflation projection almost one full percentage point higher than its forecast at the start of the year.

Refined fuel products are even more constrained. Diesel costs have climbed almost 50% more than crude oil, while gasoline has increased by about 20%, Citi reports.

Excluding food and energy, core inflation has also moved upward. Since February, Citi has raised its projections for numerous large economies by roughly 50 basis points (0.5 percentage point).

Longer-run inflation expectations across key economies stay well-anchored, Citi observes. The firm interprets this as evidence that market participants continue to have confidence in central banks.

J.P. Morgan anticipates a brief tightening cycle, forecasting an additional rate increase in December.

What Is Pushing Global Yields Higher?

Among the 27 significant central banks monitored by Citi, 20 currently have higher rate predictions compared to February. Concurrently, 10-year sovereign bond yields across various nations have increased by 60 to 100 basis points.

One factor, according to Citi, is the increasing neutral rate — the interest rate that neither boosts nor restrains economic activity. The Fed's current estimate of 3.2% is 70 basis points higher than its early 2024 figure.

Investment in artificial intelligence is another contributor, with Citi noting that such spending is progressively dependent on long-term debt markets.

Citi forecasts that the Bank of Japan will raise rates three additional times before the close of 2027, bringing its policy rate to 2%.

The US government is monitoring Japan's bond market carefully, as Japan is the largest foreign holder of US Treasury securities.

Citi further notes that AI expenditure is also moving via technology supply chains into South Korea, Taiwan, and China.

The battle against inflation can be won but is not yet over, in Citi's assessment. Persistently high oil at $100 per barrel would shift the balance of risks toward elevated inflation and diminished growth, the bank warns.