Analysts at Citi predict the Federal Reserve could cut interest rates by 200 basis points over eight meetings through the summer of 2025 as the U.S. economy cools. Citing new signs of a slowing economy and rising unemployment, the bank sees the Fed cutting rates by 25 basis points over eight times between September and July 2025. This would take the benchmark interest rate to 3.25-3.5% from the current 5.25-5.5%, which Citi expects to remain at for the rest of 2025. Traders are expecting the first rate cut to likely come in September, following Fed Chairman Jerome Powell's dovish comments on Tuesday.
“Continued softening in economic activity will prompt rate cuts over the next seven Fed meetings, in our base case,” Citi forecasts.
Chairman Powell is scheduled to testify before Congress this week amid signs of slowing inflation and a softening economy. U.S. real gross domestic product (GDP) grew at a 1.4% annualized rate in the first quarter of 2024, a sharp deceleration from 3.4% growth in the fourth quarter of 2023. Meanwhile, the U.S. unemployment rate rose to 4.1% in June from 4% in May, almost setting off a surefire recession indicator. While the unemployment rate is at an all-time low, economists worry that the current upward trend could be a sign of worsening economic conditions. Specifically, temporary employment fell by 49,000 in June, a decline that Citi calls “the type of decline typically seen during a recession as employers begin to trim their workforces among the most tenured workers.”
Related: Gas flows in Freeport, Texas, drop to near zero ahead of Hurricane Beryl
Lower interest rates could have a positive impact on the energy sector in general. Although not closely correlated, studies have found a link between interest rates and oil prices. One basic theory is that higher interest rates raise costs for consumers and manufacturers, leading to less time and money spent driving. This could lead to a decrease in demand for oil, which could lead to lower oil prices. Similarly, lower interest rates allow consumers and businesses to borrow and spend more freely, increasing demand for oil. Another theory is that higher interest rates tend to strengthen the dollar, a trend that negatively impacts many commodities, including oil.
Changes in interest rate uncertainty (VXTYN, left vertical axis) and crude oil price volatility index (OVX, right vertical axis)
The story continues
Source: Creative Commons
However, once the Fed starts lowering interest rates, the renewable energy sector is likely to emerge as the biggest winner. Renewable energy stocks have significantly underperformed fossil fuel stocks and the overall market so far this year over the past few years, but the selloff has accelerated in recent months as rising interest rates and a hawkish Fed have outweighed the Biden Administration's significant support. The iShares Global Clean Energy ETF (NASDAQ:ICLN), the world's largest green energy ETF and a comprehensive investment in clean energy, has crashed about -25% over the past 12 months. Meanwhile, the Energy Select Sector SPDR Fund (NYSEARCA:XLE) has returned 10.4% and the S&P 500 has risen 25%. Solar and wind energy benchmarks have performed similarly poorly, with the Invesco Solar ETF (NYSEARCA:TAN) plummeting 42% year to date and the First Trust Global Wind Energy ETF (NYSEARCA:FAN) returning -2.3% over the same period.
“There are dark clouds hanging over green stocks,” Martin Fransen, portfolio manager at Principal Asset Management, told the Financial Times.
The clean energy sector tends to be highly sensitive to interest rates, as renewable energy projects require developers to borrow large amounts of capital up front to build the projects. To further complicate things, the cost of electricity generated from renewables tends to be much more susceptible to rising interest rates compared to electricity generated from fossil fuels. In fact, a 2020 analysis by the International Energy Agency found that a 5% increase in interest rates would increase the levelized cost of electricity for wind and solar PV by 33%, but only slightly for natural gas plants.
Meanwhile, the renewable energy sector has received ample support from the Biden administration. Two years ago, the US Congress passed the Inflation Control Act, hailed as the most significant climate change bill in US history. The main goals of the IRA (the largest increase in federal spending on alternative energy in US history) are to strengthen energy independence, reduce reliance on Chinese imports, and revitalize the industrial sector. The IRA is expected to provide incentives worth about $1 trillion for clean technologies and spur trillions of additional investments. According to the US Clean Power Association, the IRA could more than triple clean energy production, reduce emissions by 40% by 2030, and create 550,000 clean energy jobs.
Article by Alex Kimani of Oilprice.com
Other popular articles from Oilprice.com:
Read this article on OilPrice.com