Moody's expects Fed to cut rates in May as inflation slows

NEW DELHI: Moody's expects the inflation rate to return to central bank targets by 2025 and the US Federal Reserve to start cutting rates in May.

The latest report of the global credit rating agency released on Friday also dwells on credit issues such as the expected rate of corporate defaults, and the impact of geopolitical factors, AI, and digital technology on credit metrics.

"We expect inflation to return to central bank targets by 2025 but on a bumpy path with occasional jumps that complicate policymaking and keep markets on edge. Geopolitics adds risks," the report points out.

It states that the Federal Reserve (Fed) will begin cutting rates in May, with rates falling to 4.25 per cent-4.50 per cent by year-end. The European Central Bank (ECB) will also cut rates to 3.25 by year-end. Higher UK inflation means the Bank of England will be slower to act.

According to the report, an expected normalization in Fed policy and policy efforts to preserve financial stability lower this risk. Ten-year yields will fluctuate close to 4 per cent.

The rating agency also states that the speculative-grade nonfinancial corporate default rate will peak at 4.9 per cent in the first quarter, before stabilizing in the 3.7 per cent-4 per cent range in the third and fourth quarters.

As far as commercial real estate is concerned, Moody's is of the view that rate cuts should help, but borrowing costs will remain well above the past few years.

Office is most vulnerable to further falls with remote and hybrid working the new norm.

Regarding the carbon transition financing gap, the report states that policy support and growing clean energy competitiveness is helping narrow the gap, but it will remain wide.

Dealing with the question of whether the effects of AI will show up in credit metrics in 2024?

The report states that the benefits are already visible for companies providing AI infrastructure and cloud services. But any widespread improvement in credit quality is unlikely before 2026.

The report further states that digital finance will expand in 2024, thanks to technological innovation, evolving consumer preferences and the efficiencies it offers.

But a number of obstacles will slow wider adoption.

The report also takes up the question on whether tensions between China and Taiwan will become 2024's geopolitical hotspot.

It concludes that elections in both Taiwan and the US add risks, but the economic costs that a conflict would impose on all parties act as an effective deterrent.

As far as impact of the election supercycle on global credit is concerned, the Moody's report states that industrial policy, immigration and foreign policy are likely to be key election battlegrounds.

The scale of and aggregate direction of policy decisions in these areas will determine credit effects.