Since the Fed started cutting interest rates in September, financial conditions have eased with a rise in the stock market, a tightening of credit spreads, a decline in the VIX, a rise in inflation expectations, and an appreciation of the US dollar.
The charts below show the net effects of these developments on GDP and inflation using a model of the US economy that is similar to the Fed’s model, FRBUS.
The bottom line is that Fed cuts and associated developments in financial markets will boost GDP over the coming quarters by 1 percentage point and boost inflation by 0.5 percentage points.
In short, there are significant tailwinds in the pipeline to growth and inflation coming from the Fed having started to cut interest rates and the associated easing in financial conditions.
Combined with the ongoing fiscal outlook, we continue to worry more about the upside risks to growth, inflation, and interest rates over the coming quarters.
Note: The following shocks are applied to Q4 2024: A 0.2 percentage point rise in inflation expectations, 7% appreciation in the exchange rate, 0.5 standard deviation fall in VIX, 30 bps tightening of credit spreads, -100 bps rate cuts, and -50 bps forward guidance. Source: Bloomberg SHOK model, Apollo Chief EconomistNote: The following shocks are applied to Q4 2024: A 0.2 percentage point rise in inflation expectations, 7% appreciation in the exchange rate, 0.5 standard deviation fall in VIX, 30 bps tightening of credit spreads, -100 bps rate cuts, and -50 bps forward guidance. Source: Bloomberg SHOK model, Apollo Chief Economist
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