Markets may be "too optimistic" about Fed rate cut path - RBC Capital Markets

Investing.com -- Investors may have become a "little too optimistic" about the timing of Federal Reserve interest rate cuts ahead of a key policy decision from the central bank later this week, according to a note from analysts at RBC Capital Markets.

RBC predicted that the all-important Fed Funds Rate is projected to stand at 5.25% by the end of 2024, above consensus forecasts of 5.00%. The figure is now at a more than two-decade high range of 5.25% to 5.5%.

The analysts added that Friday's closely-watched U.S. employment report "didn't do anything" to alter their view.

The U.S. economy added more jobs than expected last month, undermining expectations of a cooling labor market, potentially impacting how the Fed approaches potential interest rate cuts this year. Nonfarm payrolls rose by 272,000 in May, surging from April’s revised lower 165,000 release, according to data from the Labor Department's Bureau of Labor Statistics. Economists had called for a reading of 182,000. This was higher than the average monthly gain of 232,000 over the prior 12 months.

Average hourly earnings grew by 0.4% month-on-month, compared to 0.2% in April and projections of 0.3%. The unemployment rate, meanwhile, rose to 4.0%, above the expected 3.9%.

The figures exacerbated concerns that the Fed could delay the timing of possible rate cuts for a longer period of time than some investors had hoped. Stock markets on Wall Street fell on Friday.

Markets widely expect the Fed to keep borrowing costs on hold at more than two-decade highs at the conclusion of its next policy gathering on Wednesday, meaning the spotlight will likely shine on any indications the central bank gives about its outlook for rates.

Several Fed officials have suggested in recent weeks that they need to see more evidence that prices are reliably easing back down to their 2% target level before rolling out any rate cuts.

Fresh U.S. inflation numbers are due to be released just hours before the Fed's decision is announced on Wednesday. Economists forecast that annualized headline price growth in May matched the previous month's pace, but slowed on a monthly basis. The so-called "core" reading, which strips out more volatile items like food and fuel, is seen decelerating slightly year-on-year and staying in line with April's rate month-on-month.

The RBC analysts flagged that they see "some modest downside risk to the U.S. equity market if the Fed does nothing this year and inflation is stickier than expected."