"The financial market is excessively optimistic."
As expectations for a pivot (direction change) by the Federal Reserve (Fed) next year grow in the market, Wall Street investment banks including Goldman Sachs have issued such warnings. They predicted that the New York stock market, which has been rising on the back of excessive optimism, will undergo a correction as the year-end approaches.
According to Bloomberg on the 4th (local time), Goldman Sachs recommended responding with options trading, stating that the market's expectations for interest rate cuts next year are excessively priced in. Goldman Sachs forecasted that the Fed's rate cuts would only begin in earnest in the fourth quarter of next year. They also expected the total rate cut over the next year to be only 0.25 percentage points, far below the market's expectation of 1.25 percentage points.
The market expects rate cuts to start as early as March next year. According to the CME FedWatch tool, as of that afternoon, federal funds futures priced in a more than 60% chance of a 0.25 percentage point or greater rate cut by the Fed in March next year, and more than 87% chance by May next year. Accordingly, the prevailing forecast is that the current U.S. interest rate of 5.25?5.5% will fall below 4.00?4.25% by the end of next year.
Expectations for Fed rate cuts next year have increased recently due to slowing inflation, labor market, and consumer spending. In particular, last week’s slowdown in the core Personal Consumption Expenditures (PCE) index, the Fed’s preferred inflation gauge, has revived investor sentiment. Despite Fed Chair Jerome Powell drawing a line by saying "it is premature to predict the timing of rate cuts," his remarks are being interpreted in a dovish (monetary easing-favoring) manner as "principled statements." Bloomberg reported that "positioning for a soft landing next year and aggressive Fed easing is spreading throughout the U.S. interest rate market." Regarding this, Pravin Kothari, a Goldman Sachs strategist, pointed out excessive optimism, saying, "The market is reaching the limit of how much it can price in rate cuts without realistically considering the short-term possibility of a recession."
Wells Fargo suggested March next year as the timing for the Fed’s first rate cut but recently expressed the view that market expectations for rate cuts are excessive. Chris Harvey, a Wells Fargo strategist, appeared on CNBC recently and said, "Consumers’ predictions for rate cuts are overly optimistic," adding that the New York stock market, which has rallied on these expectations, could soon face a correction. He also predicted that consumer spending, which accounts for two-thirds of the U.S. economy, would show signs of slowing. Sam Stovall, Chief Investment Strategist at CFRA Research, said some traders still view the remainder of this year optimistically, but some believe the market may have gone too far, too fast.
Investors’ attention is focused on the dot plot and Fed Chair Powell’s press conference to be released immediately after the Federal Open Market Committee (FOMC) meeting on the 12th?13th. Vincent Reinhart, Chief Economist at Dreyfus and Mellon and a former Fed official, said, "They (the Fed) will have an awkward time this month," pointing out that Fed officials would not want the message that rate hikes are over to be interpreted as a signal that rate cuts are needed. However, renowned economist Jeremy Siegel appeared on CNBC Squawk Box that morning and argued, "Considering the flexibility of the indicators seen over the past four weeks, rate cuts should be part of the discussion at the December meeting."
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