UBS sees several Fed rate cuts next year on the back of the US recession

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US Federal Reserve Chairman Jerome Powell takes questions from reporters at a news conference after the Fed’s decision to leave interest rates unchanged, at the Federal Reserve in Washington, US, September 20, 2023.

Evelyn Hockstein Reuters

UBS expects the US Federal Reserve to cut interest rates by as much as 275 basis points in 2024, nearly four times the market consensus, as the world’s largest economy heads into recession.

In its 2024-2026 outlook for the US economy, published on Monday, the Swiss bank said that despite economic resilience through 2023, many of the same headwinds and risks remain. At the same time, the bank’s economists suggested that “there will continue to be less support for growth that allowed 2023 to overcome these obstacles in 2024.”

UBS expects deflation and rising unemployment to reduce economic output in 2024, prompting the Federal Open Market Committee to cut rates “first to prevent the nominal funds rate from ‘become more restrictive as inflation falls, and later in the year to stop the weakening of the economy.’

Between March 2022 and July 2023, the FOMC implemented a series of 11 rate hikes to bring the Fed funds rate from a target range of 0.25-0.5% to 5.25-5.5%.

The central bank has since stopped at that level, leading markets to largely conclude that rates have peaked, and begin considering the timing and size of future cuts.

However, Fed Chairman Jerome Powell said last week that he was “not confident” that the FOMC had yet done enough to return inflation sustainably to the 2% target.

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UBS noted that despite the most aggressive rate hike cycle since the 1980s, real GDP expanded 2.9% over the year to the end of the third quarter. However, yields have risen and stock markets have been under pressure since the FOMC meeting in September. The bank believes that this has renewed growth concerns and shows that the economy is not “out of the woods yet.” “

“Expansion continues to outpace higher interest rates. Credit and lending rates appear to be tightening beyond mere repayment. Labor market incomes remain under further review lower, on the web, over time,” UBS said.

“According to our estimates, consumption in the economy looks high relative to income, pushed up by fiscal stimulus and maintained at that level by excess savings. “

The bank predicts that the upward pressure on growth from fiscal stimulus in 2023 will fade next year, as household savings “thin” and balance sheets ‘ look so strong.

“Furthermore, unless the economy slows significantly, we doubt the FOMC is restoring price stability.” 2023 did better because many of these risks did not appear. However, that does not mean that they have been eliminated,” UBS said.

The US Treasury yield curve is likely to continue to steepen, the analyst says

“In our view, the private sector looks less insulated from FOMC rate hikes next year.” Looking ahead, we expect significantly slower growth in 2024, a rising unemployment rate, and meaningful reductions in the federal funds rate, as the target range expires. a year between 2.50% and 2.75%.”

UBS expects the economy to contract by half a percentage point in the middle of next year, with annual GDP growth falling to just 0.3% in 2024 and unemployment rising to almost 5% by the end the year.

“With that additional disinflationary trend, we expect monetary policy to ease next year’s recovery in 2025, pushing GDP growth back up to around 2-1/2%, a ‘ limiting the unemployment rate to 5.2% in early 2025. some slowing in 2026, partly due to expected fiscal consolidation,” said the bank’s economists.

The worst credit boom since the financial crisis

Arend Kapteyn, global head of economics and strategy research at UBS, told CNBC on Tuesday that the starting conditions are “much worse now than 12 months ago,” especially in the form of the credit rating “largely to h -historical” that is being taken out of the US Economy.

“The credit boom is now at its worst level since the global financial crisis – we think we’re seeing that in the data. You have margin compression in the US which is a good precursor to layoffs, so US margins are under more pressure for the economy as a whole than in Europe, for example, which is surprising,” he told CNBC’s Joumanna Bercetche on the sidelines of the UBS European Conference.

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At the same time, former private health care copays are growing close to zero and some of the fiscal 2023 stimulus is underway, Kapteyn noted, also reiterating the “huge gap” ” between real income and consumption which means that there is “much more opportunity for that. consumption to fall to those income levels.”

“The counter that people have then is that they say ‘well why aren’t income levels going up, because inflation is falling, disposable income should be getting better?’ But in the US, household debt service is now increasing faster than real income growth, so we basically think there’s enough to have a few negative quarters. in the middle of next year,” said Kapteyn.

Recession is defined in many economies as two consecutive quarters of contraction in real GDP. In the US, the National Bureau of Economic Research’s (NBER) Business Cycle Relations Committee defines a recession as “a significant decline in economic activity that is widespread throughout the economy and lasts more than a few months.” This includes an overall assessment of the labor market, consumer and business spending, business production and income.

Goldman ‘very confident’ in US growth outlook

UBS’s outlook on both rates and growth is well below market consensus. Goldman Sachs projects the US economy will expand 2.1% in 2024, outpacing other developed markets.

Kamakshya Trivedi, head of global FX, rates and EM strategy at Goldman Sachs, told CNBC on Monday that the Wall Street giant was “very confident” in the US growth outlook.

“Real income growth appears to be very solid and we think that will continue to be the case. Asia, so we’re very confident about that,” he told CNBC’s “Squawk Box Europe.”

Trivedi said that with inflation gradually returning to target, monetary policy could be a little more accommodative, citing some recent dovish comments from Fed officials.

“I think a combination of things — the reduced distraction from policy, a stronger business cycle and real income growth — makes us very confident that the Fed can stay on this platform,” he concluded.

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