JPMorgan: Crypto Markets Overly Hopeful on Fed Rate Cuts

• Financial Markets' Optimism Around Fed Rate Cuts Could Be Premature
• Prediction of Fed Rate Cuts Might Be Overstated
• Inflation Triggers
• Understanding The Impact on Bitcoin
• Anticipating Potential Market Responses

Financial Markets' Optimism Around Fed Rate Cuts Could Be Premature

Significant optimism exists around anticipated Federal Reserve (Fed) interest rate cuts. However, crucial economic data indicating substantial disinflation has yet to emerge. Despite this, the markets appear to underprice the Fed's ongoing dedication to tackling resurgent inflation. Such a scenario can lead to unexpected fluctuations in risk-prone assets.

Prediction of Fed Rate Cuts Might Be Overstated

Financial markets might be excessively hopeful about the timing and extent of the potential U.S. Federal Reserve policy easing through interest rate cuts this year, as per JPMorgan Asset Management. The assumption of rate reduction became prevalent as inflation in 2023 began to pull back. The Federal Reserve hinted at a potential shift towards rate cuts in its December meeting. Traders are forecasting around 140 basis points of rate cuts this year, as per the Fed funds futures market. This is nearly twice the amount indicated by the Federal Reserve's rate projection chart, also known as the dot plot, in December.

Inflation Triggers

However, significant inflation indicators closely monitored by the Fed have not shown any substantial signs of disinflation, according to JPMorgan Asset Management's macro strategy team led by Shrenick Shah. The market may be neglecting the Fed's commitment to curb potential inflation rebound, which could lead to a possible correction in risk assets, the team noted.

Later Wednesday, the Fed is slated to release the year's first rate review. The central bank is likely to maintain the benchmark interest rate between 5.25% and 5.5% and counterbalance any dovish prospects in light of renewed inflation risks.

Understanding The Impact on Bitcoin

Historically, Bitcoin$42,260 -0.64%'s movement has more or less mirrored that of stocks, declining in response to hawkish Fed developments. The cryptocurrency's fourth-quarter surge of 57% was partly driven by expected rate cuts and a weakened U.S. dollar index.

In our assessment, the market could be overly optimistic as we find scarce evidence of disinflation in designated areas considered by the Fed, specifically core services inflation and wage data, said the strategists in their note titled Macro Strategies Outlook earlier this month. Moreover, continued resilience in U.S. growth may impede the disinflation process or potentially exert upward pressure.

Anticipating Potential Market Responses

We do believe that the Fed will remain prepared to counter any emerging weakness in 2024, and it will also stay committed to fighting inflation. It will not hesitate to take action if inflation were to surge again. We view this potential scenario as being underrepresented in the markets. If acknowledged, it could trigger a down correction in risk assets and bolster bond yields, the strategists concluded.

Edited by Jonathan Stoker