Citi questions need for aggressive Fed rate hikes priced by markets

Citi Research questions whether the Federal Reserve needs the aggressive rate hikes markets are pricing in, despite forecasting 3.5% global headline inflation this year. Citi links the Fed's September rate increase to a durable economy and above-target inflation. However, a team led by Citi Global Chief Economist Nathan Sheets sees a weaker case for aggressive tightening ahead. Citi says Brent crude remains near $105 a barrel. Citi says oil prices have pushed its global inflation forecast nearly a full percentage point above its start-of-year estimate. Citi says diesel prices have risen nearly 50% more than crude oil prices, while gasoline prices have risen roughly 20% more. Citi has raised its core inflation forecasts for many major economies by about 50 basis points (0.5 percentage point) since February. Core inflation excludes food and energy. Citi says longer-term inflation expectations remain anchored across major economies. Citi interprets those expectations as a sign that investors still trust central banks. J.P. Morgan also expects a short rate-hike cycle, with one more increase in December. Citi has raised its rate forecasts since February for 20 of the 27 major central banks it tracks. Ten-year government bond yields in many countries have risen 60 to 100 basis points over the same period. Citi identifies a rising neutral rate, which neither stimulates nor slows growth, as one driver of higher yields. The Fed's neutral-rate estimate is now 3.2%, up 70 basis points from its early 2024 level. Citi identifies artificial intelligence investment as another driver of higher yields. Citi says that investment increasingly relies on long-term credit markets. Citi expects the Bank of Japan to raise its policy rate three more times by the end of 2027, bringing it to 2%. Washington is watching Japan's bond market closely, as Japan holds more U.S. Treasuries than any other foreign country. Citi says artificial intelligence spending is also flowing through technology supply chains to South Korea, Taiwan and China. Citi judges the fight against inflation winnable but unfinished. Citi warns that sustained $100 oil would increase the risks of higher inflation and weaker growth.