The Fed’s first rate cut is still on pace for June with inflation dropping like a rock, Fundstrat’s Tom Lee says

Fed Chair Jerome Powell is likely to start reducing the Fed’s balance sheet this year, analysts say.

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The Fed’s first rate cut is still on track to come in June, Fundstrat’s Tom Lee said.
He says that’s because inflation is dropping “like a rock” in most measures.
Yet investors are only pricing in a 57% chance of a rate cut by June, per the CME FedWatch tool. 

The Fed is still poised to issue its first rate cut in June as the pace of inflation continues to slow, according to Fundstrat’s head of research Tom Lee.

Lee, who correctly called the stock market’s 20% gain last year, says he expects the Fed to begin cutting rates less than two months from now. In a video for Fundstrat clients, he cited most recent inflation indicators as evidence  that prices in the economy are cooling, and pointed to three dovish signs.

First is the PCE index, which is the Fed’s preferred inflation measure, and rose 2.8% year-per-year in February, the lowest pace of price increases recorded in three years. 

Consumer inflation expectations are also “tanking,” Lee pointed, with 1-year median inflation expectations remaining around 3% for the month of February, according to the University of Michigan’s latest survey.

Lee also pointed to core inflation numbers in France — the first inflation figures in the global economy to roll out for the month of March. Inflation dropped from 0.9% to 0.2% in France last month — a sign that inflation could come in cooler across most economies, especially considering that January and February inflation numbers could be “statistical aberrations,” Lee said. 

All that points to a Fed that could be poised to cut rates sooner than markets are expecting, which is good news for stocks. Traders have been waiting for the Fed to cut rates for over the past year — but markets are only pricing in a 55% chance the Fed could cut rates 75 basis points or more this year, according to the CME FedWatch tool, down from 85% odds priced in a month ago.

Meanwhile, just 57% of investors are expecting the Fed to issue the first rate cut in June. 

That could be because markets are focused on manufacturing prices, with the ISM’s Prices Index rising to 55.8% in March. That’s the only hawkish inflation indicator that’s rolled out the past two trading days, Lee noted.

“I think this is a head fake. We’ll actually have more validation on April 10th,” Lee said, referring to the release of the March consumer price index report. “Our base case remains inflation is falling like a rock.” 

Some economists though, have warned inflation risks staying higher for longer, thanks to lingering price pressures in the economy. The Fed should wait a “couple years” before beginning to cut rates, top economist Mohamed El-Erian recently warned, as the underlying inflation rate associated with a strong economy has likely moved higher in recent years.