The Tell: Wall Street’s most pessimistic bank sees almost 5% fed-funds rate on horizon


As financial market gloom continued to deepen on Friday, Deutsche Bank, Wall Street’s most pessimistic bank, came out with yet another eye-opening view: Its U.S. economists, led by Matt Luzzetti, now expect the Federal Reserve to end its rate-hike campaign at 4.9% in 2023’s first quarter.

The notion of an almost 5% fed-funds rate, which in Deutsche Bank’s own words is
“way beyond” what the market is pricing, comes just days ahead of the Fed’s next meeting on Sept. 20-21 and as investors remain anxious about how high interest rates will have to go to wrestle the worst stretch of inflation in four decades. Investors were still trying to wrap their heads around the likelihood that the fed-funds rate target will likely rise above 4% by year-end, and the stock market continued to sell off on Friday — fueled by a profit warning by FedEx Corp. FDX, -21.85%, along with inflation and rate fears.

Few, if any, market participants have openly talked about the prospect of an almost 5% fed-funds rate target, essentially double the current level of 2.25% to 2.5%. Such a scenario would likely have an even more punishing impact on stocks than what’s been predicted by billionaire investor and hedge-fund manager Ray Dalio, who estimates that a 4.5% level on rates would produce a 20% negative impact on equity prices.

Meanwhile, one key market rate — the one-year Treasury yield TMUBMUSD01Y, 4.021% — was around 4% on Friday after breaching that level earlier — a development that some say could spill over into other rates and exacerbate worries throughout financial markets, in the U.S. and abroad.

“Matt has been consistently the highest on the street for economists in recent months” when it comes to interest-rate forecasts, Deutsche Bank’s Jim Reid, Henry Allen and Tim Wessel wrote in a note Friday. The bank’s U.S. economists revised their expectations after Tuesday’s unexpectedly hot consumer-price index report for August, and the upgrade is now closer to the 5% to 6% range that some at Deutsche Bank think is needed to tame inflation.

Friday brought another downbeat day in financial markets, with all three major stock indexes DJIA, -1.02% SPX, -1.33% COMP, -1.63% lower since the New York open. Meanwhile, Treasury yields initially climbed on a selloff in government debt, before stabilizing as pockets of bond-buying emerged.

Deutsche Bank was the first major Wall Street bank to call a U.S. recession in April. That same month, it went out further on a limb to say that it saw downside risk to its own pessimistic view. In June, Wessel, a macro strategist, said he saw a chance that inflation fails to decelerate. And just three days ago, Allen, a research analyst, said “that the pessimists will sadly prevail on this occasion” when it comes to the debate over whether the U.S. economy can achieve a soft landing.

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