With the Fed worrying less about inflation and more about growth, the risks are rising that easier financial conditions triggered by the Fed’s pivot could start another rise in inflation driven by higher prices on housing, labor, services, and goods, see chart below.
The “Fed pivot” on December 13 to a dovish stance underscored the rapidly shifting outlook for both growth and inflation. Markets have reacted in kind. But the bottom line is that going into 2024, we still see upside risks to inflation, downside risks to growth, and expect rates to stay higher and for longer than the rest of the market does.
We published our consolidated views in my newest white paper, 2024 Economic and Capital Markets Outlook: What’s Next After the “Fed Pivot”? You can download it here.
I will also be discussing the contents of the paper and my views in detail in an Apollo Academy class today, Dec. 20, at 11:00 ET (eligible for a CE credit). Register here.
The “Fed pivot” in December to a dovish stance underscores the rapidly shifting outlook for both growth and inflation. Going into 2024, we still see upside risks to inflation, downside risks to growth, and expect rates to stay higher and for longer than the rest of the market does. In this paper and on-demand class, Chief Economist Torsten Sløk will discuss the implications for corporate growth, banking, consumer spending, and financial markets.
Key Takeaways
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Last week, the Fed went from expecting another 25-basis point hike to now expecting 75-basis point cuts in 2024, and the chart below quantifies the impact of this 100-basis point pivot on the economy. At the same time, the market now expects 150 basis points in Fed cuts in 2024, and 10-year interest rates have declined by 100 basis points since they peaked at 5% in October.
The Fed pivot combined with a one standard deviation decline in VIX, a 60-basis point tightening in IG spreads since March, and a $20 decrease in oil prices since September will boost GDP growth by 1.5% over the coming quarters, see chart below.
The CBO estimates that potential growth in the US is 2%, so a 1.5% boost to GDP is significant. Stronger GDP growth will boost demand for housing, labor, airlines, hotels, restaurants, and goods, which ultimately will put renewed upward pressure on inflation.
The conclusion for markets is that the Fed pivot last week complicates the Fed’s goal of getting inflation back to 2%, and as we enter 2024, the pendulum will soon swing back from a dovish Fed to a more hawkish Fed.
All supply chain indicators are now back near 2019 levels, see charts below and in this chart book.
FOMC members have since 2021 steadily been revising up their forecasts for where they think the Fed funds rate will be by the end of 2024, see chart below. This changed at their meeting earlier this week, where the Fed signaled that they now see interest rates in 2024 lower than they thought in September.
This pivot in communication, however, does not suggest that the inflation problem has been solved. Looking into 2024, there are upside risks to inflation (from a recovering housing market and easier financial conditions) and downside risks to growth (from the lagged effects of Fed hikes on consumers, firms, and banks).
The bottom line is that they may have pivoted their communication, but the Fed is not yet out of the woods, and the upside risks to inflation and downside risks to growth remain significant.
I will discuss the Fed pivot and our outlook for markets in 2024 in detail in an Apollo Academy class on Wednesday, December 20 at 11 am (eligible for 1 CE credit). Register today.
Data from the ECB shows that ECB rate hikes have had a very uneven impact on euro area countries with interest rates for firms increasing much more in periphery countries than in core countries.
For example, interest rates on outstanding loans to non-financial corporations in Ireland and Portugal are currently around 5.6% versus 3.3% in Germany and France, see chart below.
The bottom line is that ECB rate hikes negatively impact the periphery more than the core.
Trading volume in investment grade bonds was at post-Covid highs in November and significantly above 2019 levels, see chart below.
In recent months, we have seen a significant increase in the number of men age 55 to 64 joining the workforce, see chart below.
There are more Chapter 11 bankruptcy filings in Texas, New Jersey, Delaware, and New York than in other states, see map below.
