With inflation slowing and unemployment continuing to drop, recessionary fears appear to be easing, and the fabled soft landing appears to be a real possibility. So when will the Federal Reserve pull back on interest rate hikes, reverse course, and cut interest rates? “That’s a $1 million dollar question,” said Director of FIG Research Nathan Stovall in our recent thought leadership webinar. Here are the highlights of his predictions for interest rates and monetary policy over the next couple of years.
Stovall noted that economists have revised predictions recently in response to better-than-expected inflation news. “Heading into [November 14, 2023]'s Consumer Price Index reading, which came in below expectations, our economists within our GAA team expected the Fed to hold rates through the first half of '24 and then begin cutting in the second half, beginning in the second quarter and then cut further from that point, eventually, lowering the target rate by 100 basis points by the first quarter of ’25,” Stovall said. “The futures market was pretty much there, too, but that CPI print really changed everything, and I expect that our expectations are going to be different as well. CPI was up 3.2% year-over-year. But importantly, it helped flat month-over-month. So we're seeing really good progress there in terms of inflation. We see a huge market response to that move.”
As a result, Stovall said, economists have revised projections to expect rate cuts sooner. “Fed futures is now pegging a cut possibly in March of ‘24 and putting over half, over 50% possibility of cut in May of '24 with further cuts, taking us down 125 basis points by year-end 2024.”
The more optimistic predictions are already having an impact on both the bond and equities markets, Stovall said, on the day after that November 14 CPI announcement. “Long-term rates plunge on the move,” he observed. “The yield on the benchmark, 10-year treasury dropped almost 20 basis points, continued to come off recent highs near 5%, down to 4.5%. And we saw investors jump up and down on that CPI print. Broad market rally.”
Stovall said he saw an impact on bank stocks in particular. “Bank stocks, which have taken huge hits this year due to higher rates because they’ve had the liquidity pressures and concerns over credit, they rallied massively yesterday, and we've seen a continued rally today. And ultimately, that's not shocking. We knew investors were waiting for a pause, and we found this in our report too. 70% of investors we surveyed in the October edition of our Investment Manager Index said their investment appetite would either increase or strongly increase if Fed funds stabilize, and it seems like we're there now.”
Stovall said that optimism for a non-recessionary soft landing persists even with an inverted bond yield curve. Asked about the trend in Treasury securities that has seen lower yields on 10-year bonds than 2-year bonds, Stovall said, “Sure. It's one of the key recessionary indicators, and it's been inverted. That spread has been negative for over a year and a half now. The one we look at more closely is that 3-month to 10-year spread, it's more accurate in terms of a predictor recession. It's been negative as well for a year. So pretty ugly. And I think close to 90% of the time, a recession does follow within 12 months after that spread is inverted.”
Nonetheless, he added, “The thing is, though, we seem closer to the soft-landing talk, and the market is getting closer there. And with each passing day, with the labor market holding up and the economy holding up to higher rates, it might not prove correct this time. We're talking about a recession almost every day, and every day, we're not getting one. So let's hope it's wrong again, but it has been accurate in the past.”
To hear further insights from Stovall on the U.S. economic outlook, access our complimentary, on-demand webinar.
For more on how macroeconomic trends may affect capital markets in 2024, read our Big Picture outlook report.