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.
New White Paper: 2024 Outlook: What’s Next After the “Fed Pivot”?
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.
2024 Outlook: What’s Next After the “Fed Pivot”?
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
- The members of the Federal Reserve Open Market Committee (FOMC) “pivoted” to a more dovish stance in their last meeting of the year on December 13, holding rates steady and signaling that the inflation outlook has improved more quickly than anticipated. They also suggested three potential rate cuts in 2024.
- The “Fed pivot” underscores the rapidly shifting outlook for both growth and inflation. Going into the new year, we still see upside risks to inflation and downside risks to growth. Because:
- Despite signaled Fed rate cuts in 2024, we expect interest rates to stay higher and for longer than the rest of the market does. We arrive at our thesis through a combination of cyclical and secular drivers, including still-tight Federal Reserve monetary policy, higher borrowing needs by the US Treasury, the loosening of yield-curve control policy in Japan, and reduced buying and diminished inventory of US debt held by China and others.
- Two major factors driving consumer spending are largely unrelated to current Fed policy: Households are running out of excess savings and student-loan payments are restarting. The combination of these two dynamics increases the odds of a meaningful slowdown in consumer expenditures, a key driver of US growth.
- We see many signs that the Fed’s rate hikes are working to cool off the economy. Consumers are already feeling the pinch, with increased delinquencies in both credit-card debt and auto loans. Similarly, a corporate default cycle has started, and employment is beginning to soften. Finally, bank-loan growth has been slowing sharply in recent months.
- Despite the Fed’s aggressive tightening campaign, inflation remains above the central bank’s 2% annual target. We’ve long argued that rates will stay higher and for longer than the market expects. But, if above-target inflation persists, they may go higher yet.
- All that said, we do not entirely discount the possibility of upside economic surprise. This idiosyncratic economy has defied consensus predictions for some time now, and it may continue to do so. A soft landing is not out of the question.
- The implications for capital markets?
- We believe private credit offers an attractive opportunity today given higher yields in general and on senior secured debt in particular—allowing investors to boost income generation in their portfolios with downside protection.
- Opportunities in private equity are likely to continue to emerge among potential distressed companies that come along with the combination of slowing growth and high rates. Moreover, we see opportunities in assets that can offer some level of inflation protection, such as infrastructure.
- In real assets, particularly real estate, we see more compelling risk-adjusted return opportunities in credit than in equity at this stage of the economic cycle.
- Public equities are as unappealing as they have been in 20 years due to stretched valuations. Public bonds—with risk-free yields on 10-year Treasuries hovering around 4.0% as of this writing—appear attractive to investors interested in “locking” higher rates in their fixed-income portfolios. That said, attention to duration risk remains warranted.
The information herein is provided for educational purposes only and should not be construed as financial or investment advice, nor should any information in this document be relied on when making an investment decision. Opinions and views expressed reflect the current opinions and views of the authors and Apollo Analysts as of the date hereof and are subject to change. Please see the end of this document for important disclosure information.
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The Standard & Poor’s 500 (“S&P 500”) Index is a market-capitalization-weighted index of the 500 largest U.S. publicly traded companies by market value.
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Fed Pivot Pushing the US Economy Back to No Landing Scenario
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.
Supply Chains Back to Normal
All supply chain indicators are now back near 2019 levels, see charts below and in this chart book.
What Comes After the Fed Pivot?
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.
Uneven Transmission of Monetary Policy in Europe
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.
Daily Average Trading Volumes for IG
Trading volume in investment grade bonds was at post-Covid highs in November and significantly above 2019 levels, see chart below.
Significant Increase in the Number of Men Age 55 to 64 Joining the Labor Force
In recent months, we have seen a significant increase in the number of men age 55 to 64 joining the workforce, see chart below.
Busiest Bankruptcy Courts
There are more Chapter 11 bankruptcy filings in Texas, New Jersey, Delaware, and New York than in other states, see map below.