Further rate cuts from the Federal Reserve could play a crucial role in sustaining economic growth in the United States, according to UBS strategists.
Recent economic indicators have shown unexpected resilience, particularly in the labor market. The September employment report highlighted stronger payroll and wage growth, coupled with a decline in the unemployment rate. Despite these positive labor statistics, sentiment among businesses and consumers appears to be waning. Surveys indicate a dip in confidence, which could pose challenges for sustained economic momentum.
However, UBS analysts expressed optimism, stating that with the support of Fed rate cuts, they anticipate continued growth at a healthy pace in the upcoming quarters.
Inflation, which surged during the pandemic, has shown signs of moderation over the past two years. The Federal Reserve aims for a 2% target for Personal Consumption Expenditures (PCE), with core PCE—excluding volatile food and energy prices—serving as a more reliable gauge of underlying inflation trends. In August, PCE inflation slowed to 2.2% year-over-year, and UBS forecasts a further decline to 2.1% in September, aided by decreasing gasoline prices. Shelter costs have emerged as the primary driver of inflation, taking longer to stabilize than initially anticipated. However, recent data suggests a turning point, which could help contain overall inflation in the months ahead.
Despite the solid wage growth observed, UBS strategists caution that inflation may remain slightly above the Fed's 2% target in the medium term.
The emergence of downside risks in the labor market earlier this year prompted the Federal Reserve to initiate its rate-cutting cycle with a larger-than-expected 50-basis-point reduction in September. However, the recent stronger-than-expected economic data diminishes the likelihood of another substantial cut of the same magnitude in the near term. UBS maintains that the Fed is likely to implement a 25-basis-point cut at its two remaining meetings this year, with a gradual shift to a quarterly pace in 2025. The September dot plot revealed that nine out of 19 Federal Reserve participants anticipate fewer than 50 basis points of additional cuts in 2024. Public comments from Fed officials suggest a growing sentiment that it may be appropriate to hold policy steady during the upcoming November meeting. Currently, markets are pricing in approximately 1.7 rate cuts by December, reflecting a 30% probability of a skipped cut this year. UBS believes that even if the Fed decides to forgo a cut, it would not significantly alter the broader trajectory of monetary policy, as the central bank moves toward a neutral stance by 2025.
The interplay between Fed rate cuts and economic indicators is critical for investors navigating the current financial landscape. As the labor market shows resilience, the potential for sustained economic growth could provide a favorable environment for equities and other risk assets. However, the mixed signals from consumer and business sentiment underscore the importance of closely monitoring economic data and Fed policy decisions. The evolving inflation landscape, particularly in relation to shelter costs, will be a key factor influencing future monetary policy. As UBS strategists suggest, the potential for AI-driven productivity gains could reshape inflation dynamics, offering a long-term perspective for investors.
In summary, the outlook for the U.S. economy hinges on the Federal Reserve's ability to navigate rate cuts while addressing inflationary pressures. The interplay of labor market strength, consumer sentiment, and inflation trends will be pivotal in shaping the economic landscape in the months and years ahead. Investors should stay informed and prepared for potential shifts in monetary policy as the Fed adapts to changing economic conditions.