Citi Says Fed May Not Need Aggressive Hikes Markets Are Pricing

Citi Research questions whether the Federal Reserve (Fed) needs the aggressive hikes markets are pricing in. The bank holds that view even as it forecasts global headline inflation of 3.5% this year.

The Fed raised rates in September, which Citi links to a durable economy and inflation above target. However, a team led by Global Chief Economist Nathan Sheets sees a weaker case for aggressive tightening ahead.

How Does Citi Weigh Inflation Against Fed Hikes?

Citi says Brent crude remains near $105 a barrel. That has pushed its global inflation forecast nearly a full percentage point above its start-of-year estimate.

Meanwhile, refined fuels are tighter still. Citi says diesel prices have risen nearly 50% more than crude oil, and gasoline roughly 20% more.

Core inflation, which strips out food and energy, is also higher. Citi has lifted its forecasts for many major economies by about 50 basis points (0.5 percentage point) since February.

However, longer-term inflation expectations remain anchored across major economies, according to Citi. The bank reads that as a sign investors still trust central banks.

Similarly, J.P. Morgan expects a short cycle, with one more December hike.

What Is Pushing Global Yields Higher?

Of the 27 major central banks Citi tracks, 20 now carry higher rate forecasts than in February. Over the same period, 10-year government bond yields in many countries have risen 60 to 100 basis points.

Citi names a rising neutral rate, the level that neither stimulates nor slows growth, as one driver. At 3.2%, the Fed’s estimate now sits 70 basis points above its early 2024 level.

Another driver is artificial intelligence (AI) investment, which Citi says increasingly relies on long-term credit markets.

In Asia, Citi expects the Bank of Japan to hike three more times by the end of 2027. That would lift its policy rate to 2%.

Meanwhile, Washington is watching Japan’s bond market closely, since Japan holds more Treasuries than any other foreign country.

Citi adds that AI spending is also flowing through technology supply chains to South Korea, Taiwan, and China.

Citi judges the inflation fight winnable but unfinished. Sustained $100 oil, it says, would tilt risks toward higher inflation and weaker growth.