Deutsche Bank says why interest rate cuts this year could disappoint markets

The Federal Reserve's rate cuts may not come as quickly as investors hope.Win McNamee/Getty Images

• The market's hopes for major cuts this year are unlikely to be fulfilled, wrote Deutsche Bank.

• Today's economy is similar to that of 1995, when cuts fell short of market forecasts.

• An AI productivity cycle could prevent the US from falling into recession and keep interest rates high.

Markets may find that the expected rate-cutting cycle falls short of expectations, Deutsche Bank's George Saravelos wrote on Friday.

This is not so much due to the timing, but rather because interest rates will not fall as much as predicted. Futures markets are forecasting five to six cuts this year, which will bring the key interest rate down by over 100 basis points by the end of the year.

“In a soft landing scenario, one can expect the Fed to cut interest rates to nominally neutral,” Saravelos wrote, referring to the level of interest rates that neither constrains nor expands the economy. “The problem is that no one knows where that theoretical value is in real time.”

Given this uncertainty, it is likely that the Federal Reserve is headed for a repeat of 1995, he wrote. This year, the central bank cut interest rates by 75 basis points, below hopes for a 200 basis point cut.

As with today's economy, declining inflation, labor force growth, and economic strength all played a role in the modest adjustment nearly thirty years ago. The technology cycle of the mid-1990s kept the economy buoyant, and worries about a sharp downturn never materialized.

“Can this experience be repeated? Artificial intelligence is a technology that could drive a new cycle of productivity. We have also written about the dramatically reduced interest rate sensitivity of the US economy,” Saravelos wrote.

So far, the Fed has paused interest rates in the 5.25% to 5.50% range. At its last FOMC meeting, it noted that confidence in disinflation needs to be strengthened before policy shifts.

Large-scale arguments may have lost some of their edge after January's jobs report, in which new jobs nearly doubled expectations. And while some still see the risk of a downturn for the overall economy, others have pointed to continued investment strength as a tailwind.

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