While the Fed’s rate hikes have reined in growth, especially among over-levered consumers, corporates, and banks, the easing of financial conditions since the “Fed pivot” in December continues to offset the effect of higher rates. For the rest of 2024, we expect economic growth to be higher than consensus and inflation to stay above the Fed’s target. We see no Fed cuts in 2024.
Key Takeaways
- The US economy has shown more resilience and stamina than most people expected when the Federal Reserve started raising interest rates in March 2022. But now, more than two years into the Fed’s tightening campaign, we find ourselves in a state of unstable equilibrium, with powerful forces pulling the economy in oppositive directions.
- On the one hand, the lagged effects of Fed rate hikes continue to rein in growth, with higher borrowing costs biting into over-levered consumers, corporates, and banks alike. The upshot? Rising consumer delinquencies, higher corporate bankruptcies, and increased pressure on some banks’ balance sheets, especially smaller regional banks.
- On the other hand, the Fed “pivot” in December 2023 triggered an easing of financial conditions—bond issuance surged, M&A activity awakened, risky assets rallied, and bond spreads tightened meaningfully. These easier conditions have at least partly neutralized the effects of the Fed hikes, paving the way for a reacceleration in both economic growth and inflation.
- Which force is likely to win this economic tug of war?
- Given the current underlying strength of the US economy, we believe that easier financial conditions will continue to offset the effects of the Fed rate hikes, at least for the next three quarters, driven by strong consumer spending (particularly on services), still high government spending (as a result of several recent spending bills), still strong aggregate corporate earnings, and the “wealth effect” triggered by rising asset prices.
- As a result, we expect US economic growth to come in above consensus in 2024, at 2.5%, on the back of a still strong employment picture. We expect inflation to remain above the Fed’s 2% target for the foreseeable future, despite a mild reading of the consumer price index (CPI) in May. As of this writing, we remain confident in the view we’ve held since last year: Interest rates will remain higher for longer. We see no Fed cuts in 2024.
- The upshot for financial markets? We believe that private credit remains a compelling asset class. In equities, value can offer more favorable risk-reward than growth.
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