Citi: Fed Could Cut Interest Rates By 200 Points Through 2025

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Analysts at Citi have predicted that the U.S. Federal Reserve could slash interest rates by 200 basis points in its next eight meetings through the summer of 2025 as the U.S. economy cools down. Citing fresh signs of a slowing economy and growing unemployment, the bank has forecast that the Fed will trim rates by 25 basis points eight times, starting in September and extending to July 2025. This will lower the benchmark rate from 5.25%-5.5% currently to 3.25%-3.5%, a level that Citi expects to hold for the rest of 2025. Dovish comments from Fed Chair Jerome Powell on Tuesday have given traders hope that the first rate cut is likely to come in September.

A continued softening of activity will provoke cuts at each of the subsequent seven Fed meetings, in our base case,” Citi has predicted.

Powell is set to testify before Congress this week amidst signs of slowing inflation and a softening economy. U.S. real gross domestic product (GDP) increased at an annual rate of 1.4 percent in the first quarter of 2024, marking a sharp slowdown after posting growth of 3.4% in Q4 2023. On the other hand, U.S. unemployment rate ticked up to 4.1% in June from 4% in May, nearly triggering a reliable recession indicator. Whereas unemployment remains at historical lows, economists are concerned that the current upward trajectory is a sign of deteriorating economic conditions. To wit, June saw a decline of 49,000 temporary services jobs, with Citi calling it “the type of decline that is typically seen around recessions as employers begin reducing labor with the least strongly attached workers.”

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Falling interest rates could provide a nice boon for the energy sector in general. Although not tightly correlated, studies have revealed a nexus between interest rates and oil prices. One of the basic theories stipulates that increasing interest rates raise consumers’ and manufacturers’ costs, which reduces the amount of time and money people spend driving. This translates to less demand for oil, which can cause oil prices to drop. Similarly, when interest rates drop, consumers and companies are able to borrow and spend money more freely, which drives up demand for oil. Another theory stipulates that rising interest rates tend to strengthen the dollar, a trend that hurts many commodities including oil.

The evolution of interest rate uncertainty (VXTYN; left vertical axis) and the oil price volatility index (OVX; right vertical axis)

Source: Creative Commons

However, the renewable energy sector is likely to emerge as the biggest winner when the Fed starts cutting interest rates. Over the past few years, renewable energy stocks have badly underperformed their fossil fuel peers and the broader market in the current year, with the selloff accelerating in recent months thanks to higher interest rates and a hawkish Fed outweighing considerable backing by the Biden administration.  The iShares Global Clean Energy ETF (NASDAQ:ICLN), the world’s largest green energy ETF and a catch-all bet on clean energy, has crashed nearly -25% over the past 12 months, compared to 10.4% return by the Energy Select Sector SPDR Fund (NYSEARCA:XLE) and a 25% gain by the S&P 500. The solar and wind energy benchmarks have not fared any better, with Invesco Solar ETF (NYSEARCA:TAN) having cratered 42% YTD while First Trust Global Wind Energy ETF (NYSEARCA:FAN) has returned -2.3% over the timeframe.

There’s a dark cloud hanging over green stocks,” Martin Frandsen, portfolio manager at Principal Asset Management, has told the Financial Times. 

The clean energy sector tends to be highly sensitive to interest rates because renewable energy projects require developers to borrow lots of capital upfront to build projects. To complicate matters further, the cost of electricity generated from renewable energy tends to be impacted much more by rising interest rates compared to electricity generated from fossil fuels. Indeed, a 2020 analysis from the International Energy Agency found that a 5% rise in interest rates increases the levelized cost of electricity from wind and solar by 33% but only marginally for natural gas plants. 

Meanwhile, the renewable energy sector has enjoyed ample backing by the Biden administration. Two years ago,  the United States Congress passed the Inflation Reduction Act, hailed as the most important climate legislation in United States history. A major goal of IRA–the largest federal government spending increase on alternative energy in U.S. history–is to strengthen energy independence, reduce dependence on Chinese imports, and reinvigorate the industrial sector. The IRA is expected to provide some $1 trillion worth of incentives for clean technologies and drive trillions more in investments. According to the American Clean Power Association, IRA could more than triple clean energy production, cut emissions by 40% by 2030, and create 550,000 clean energy jobs. 

By Alex Kimani for

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