US: Interest rates are likely to drop – Commerzbank

In recent weeks, I have often read that the inflation shock triggered by US tariffs will not be too severe, and that even if it is, it will only be temporary, with the possibility of interest rate cuts by the Fed. This is either justified by survey-based inflation expectations that are no longer quite so high, or by subdued inflation figures, as in the case of the US president, Commerzbank's FX analyst Michael Pfister notes.

Inflation to reach around 3.5% in the coming year

"Central bankers should probably refrain from assessing transitory inflation risks after misjudging the situation during and shortly after the pandemic. It is not at all easy to predict how transitory an inflation shock will ultimately be. The decisive factor is that the US dollar has appreciated enormously in recent years because the Fed has been one of the most cautious central banks. If inflation risks rose again, higher key interest rates were generally expected. This was the case when Donald Trump's election became increasingly likely, for example, and inflation expectations rose significantly in view of the expected inflationary policy."

"Market expects inflation to reach around 3.5% in the coming year and interest rates to fall by over 100 basis points. Since the beginning of April, expectations have also tended to move sideways – although it should be noted that inflation expectations are continuing to shift further into the future, as inflation is being viewed here in one year's time, starting from the rolling starting point."

"Even if the risky assumption that US inflationary pressure triggered by the trade war is temporary proves correct, this assumption is likely to influence market expectations. We are moving away from a Fed that actively responds to inflation expectations towards other central banks that are quicker to cut interest rates than raise them. This is another bad sign for the US dollar."