The current economic slowdown signals a series of interest rate reductions by the Federal Reserve, with projections indicating as many as six cuts in 2024, according to a recent analysis by ING Economics.
This anticipated monetary policy adjustment is in response to a confluence of factors including subdued inflation, a decelerating job market, and a dimming consumer spending forecast.
ING's chief international economist, James Knightley, notes this aligns with the Fed's objectives of moderated growth and cooling inflation, reducing the necessity for further policy tightening. However, the economic outlook remains increasingly challenging.
Knightley anticipates the initiation of rate cuts in 2024's second quarter, proposing up to six cuts of 25 basis points each, amounting to a total reduction of 150 basis points. This trajectory is expected to continue into 2025 with at least an additional four cuts. This contrasts with the futures market's projection of a 125 basis point reduction in 2024.
Projected rate cuts would lower the effective Federal Funds rate to approximately 3.83% by the end of 2024, and further to 2.83% by the close of 2025, from the current rate of 5.33%.
While these cuts are designed to stimulate the economy, their impact is typically delayed, often taking 12-18 months to manifest. The gradual nature of Knightley's forecast suggests a resilient economy that may avoid immediate drastic cuts to zero percent, a common response in more severe economic downturns.
Despite a robust job market, evidenced by low weekly jobless claims, there's a noticeable cooling with a gradual increase in continuing claims. This suggests firms are hesitant to lay off workers but are also cautious about new hiring - indicative of a cooling, yet stable, labor market.
Consumer spending, though currently robust, faces headwinds in 2024. Challenges include stagnating real household incomes, increased credit card delinquencies, and the financial burden of resuming student loan payments. Knightley points out that to date, spending growth has been sustained by dwindling savings and increased debt usage. However, he warns of the likely impact of tighter credit conditions and high borrowing costs on household credit flow, compounded by the depletion of pandemic-era excess savings for many.
This analysis paints a picture of an economy balancing precariously, yet not beyond recovery. If the Federal Reserve can effectively lower interest rates ahead of a recession, it may prevent a more severe economic downturn. On the other hand, failure to act timely could necessitate more aggressive rate cuts. UBS, for instance, predicts a significant 275 basis point reduction in the event of a recession.
