While the Federal Reserve's unexpectedly sharp hawkish turn and subsequent retractions of easing expectations by major Wall Street institutions have dominated the narrative, Citigroup is holding firm with a contrarian view, maintaining that interest rate cuts this year remain the most likely outcome, with its base case scenario targeting a restart of the easing cycle in October.
At the June FOMC meeting, the interest rate dot plot showed nine of the eighteen officials projecting a rate hike this year, far exceeding market and analyst expectations. Chair Wash's post-meeting statement formally removed the "easing bias" language and refrained from providing any forward guidance. In response, swap markets rapidly brought forward expectations for the first hike from March 2027 to October of this year, with markets currently pricing in approximately 37 basis points of tightening for the remainder of the year. The 2-year Treasury yield posted its largest single-day gain since March following the meeting.
Wall Street's Surrender
Confronted with this hawkish shock, Wall Street firms have been shifting their stances. Deutsche Bank formally retracted its easing forecast in a recent report, now expecting the Fed to hike rates by 25 basis points each in September and December, a cumulative 50 basis points that would push the policy rate to 4.1%. It also warned that action could be brought forward to July. Rob Kaplan, Vice Chairman at Goldman Sachs and former Dallas Fed President, cautioned that if inflation data remains stubborn, the Fed could restart rate hikes as early as autumn, likely in a series of two to three consecutive moves.
Citigroup's Contrarian Stance
In stark contrast, the team led by Citigroup's Andrew Hollenhorst is sticking to its base-case forecast: the next policy move will be a cut, not a hike. Their baseline scenario involves a 25-basis-point cut in October, followed by another 25-basis-point reduction in December and a third in January 2027. Citigroup's core arguments hinge on three pillars: a sharp decline in oil prices is removing a major upside inflation risk; a trend of rising initial jobless claims is replicating seasonal weakening patterns seen in 2024 and 2025; and the core PCE measure is increasingly appearing as an "outlier" among inflation gauges, with its strength reflecting stock price gains more than broad consumer price pressures.
Rationale One: Falling Oil Prices Ease Inflation Risk
The first pillar of Citigroup's forecast is the rapid decline in oil prices. The bank argues that lower oil will translate into cheaper gasoline, thereby eliminating a primary source of recent inflationary pressure. Market-based inflation expectations have already fallen alongside oil, with the 10-year inflation breakeven rate dropping to levels seen before the recent conflict. Citigroup contends that if Fed officials had more time to digest this latest energy price development, the hawkish tone of the June FOMC meeting would have been notably softer. It expects inflation data to moderate in coming months as the impact of lower oil prices materializes, helping to push more officials toward a dovish stance by September and creating conditions for a rate cut before year-end.
Rationale Two: Labor Market Weakness Follows Seasonal Pattern
The second core argument focuses on early signs of labor market softening. Both initial and continuing jobless claims have been trending higher for several weeks. Citigroup notes this pattern appeared in both 2024 and 2025, preceding a series of weaker monthly employment reports and rising unemployment rates. A rise in the unemployment rate is a key driver in Citigroup's expectation for a Fed rate cut this year. The bank forecasts initial claims (for the week of June 20) to remain around 224,000, with continuing claims edging up to 1.813 million, and the 4-week moving average continuing to climb. While absolute levels remain low, a persistent uptrend would align with a view of gradual labor market weakening. On the broader economy, Citigroup's tracking estimate for Q2 GDP growth is 2.5%. While consumer spending showed resilience with the control group of retail sales rising 0.7% month-on-month in May, real disposable income growth has slowed to near zero, and the savings rate remains low, suggesting downside risks to spending growth are building.
Rationale Three: Core PCE as an Outlier
The third pillar of Citigroup's contrarian call involves questioning the core PCE data itself. While the May core CPI rose a mild 0.21% month-on-month, Citigroup expects the upcoming May core PCE reading to show a much stronger 0.37% increase, indicating a significant divergence. The bank attributes the current strength in core PCE to its unique composition: the measure is highly sensitive to AI-related prices and is directly boosted by stock market gains. The May PPI showed portfolio management fees surged 4.8% month-on-month, primarily reflecting the rebound in stock prices from early April lows to early May highs, rather than genuine consumer-side price pressures.
In a cross-comparison, other inflation measures like the Dallas Fed's Trimmed Mean PCE, the San Francisco Fed's Cyclical PCE, the Cleveland Fed's Median PCE, and core CPI all show more moderate inflation trends than core PCE. Citigroup argues core PCE is increasingly becoming an "outlier" among inflation indicators, not a reliable signal of broad consumer price pressures. The bank expects the gap between core PCE and core CPI to narrow in the second half of the year as AI-related prices plateau, with the overall inflation trajectory moving more in favor of policy easing. Under its forecast path, the year-on-year core PCE inflation rate is expected to gradually decline from around 3.3% currently to the 2.1%-2.2% range by mid-2027.
Wall Street's Revised Forecasts
Despite Citigroup's stance, the hawkish shock from Chair Wash has prompted widespread revisions elsewhere. Deutsche Bank's chief US economist Matthew Luzzetti and his team stated that their prior reluctance to upgrade forecasts stemmed from two major uncertainties: the high degree of economic uncertainty stemming from geopolitical tensions and the unclear monetary policy reaction function of the new Fed Chair. The June FOMC outcome effectively resolved both concerns.
Deutsche Bank significantly raised its inflation forecasts, lifting its core PCE expectations for end-2026 and 2027 to 3.2% and 2.5%, respectively. Its updated base case now calls for two 25-basis-point Fed hikes in September and December, totaling 50 basis points, lifting the rate to 4.1%. It then expects the Fed to hold steady throughout 2027, only beginning to cut in the first half of 2028. The bank also warned of hawkish risks: if Chair Wash has publicly committed to "fixing" the price stability issue and the Committee does not act promptly, its credibility could be tested—implying a hike could come as early as July. Furthermore, to fully reverse the easing effect generated by last year's consecutive cuts, the total annual tightening might need to be as much as 75 basis points.
Goldman Sachs' Rob Kaplan explicitly stated that if inflation data fails to cool between now and September, a rate hike in the autumn would be the "prudent course." He emphasized that Fed policy adjustments rarely occur as isolated, single actions; rate moves typically unfold in a series of two to three steps: "If you act in September, you need to be prepared that there could be one or two more [hikes]." Kaplan's warning, grounded in historical experience from multiple policy cycles, serves as a cautionary note for the market.
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