After the Fed started raising interest rates in March 2022, the banking sector started pulling back, and the decline in credit growth was magnified by the regional banking crisis in March 2023.

With the Fed signaling throughout 2024 that rate cuts are coming, banks are now showing more willingness to lend.

Our updated US banking sector outlook is available here. The charts below show that unrealized losses on investment securities are improving, the share of households reporting that it is harder to obtain credit than a year ago is declining, lending standards on consumer loans are improving, banks are more willing to lend, and loan growth is rising, driven by the large banks.

The bottom line is that tailwinds to the economic outlook in 2025 are driven not only by high stock prices, high home prices, low unemployment, and potential Trump economic policies, but also by banks easing credit conditions as a result of the Fed signaling lower rates ahead.

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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.

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The first chart below shows that Fed hikes have not had the desired effects on firms. You would normally expect that when interest rates go up, corporates see an increase in debt-servicing costs.

But because of locked-in low interest rates combined with strong corporate earnings, net interest payments as a share of operating surplus have been going down.

The bottom line is that Fed hikes have not only had a limited negative impact on consumers because of locked-in low mortgage rates (see the second chart) but they have also had a very small impact on corporates because of locked-in low interest rates and rising earnings.

In short, the transmission mechanism of monetary policy has been much weaker than the economics textbook would have predicted. This is because consumers and firms locked in low interest rates during the pandemic.

As a result, the economy never slowed down when the Fed raised interest rates, see the third chart. And now the Fed is cutting, boosting asset prices and growth in consumer spending and capex spending further.

To be sure, households and firms with weak earnings, weak revenue, and weak cash flows have been hit by Fed hikes. But the aggregate outcome seen in the charts below shows that, from a macro perspective, the negative effects of Fed hikes on corporates and consumers have been small.

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Our 2025 outlook for private markets is available here. Happy New Year.

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