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 has shown signs of weakness.
Inflation, which surged during the pandemic, has been gradually easing over the past two years. The Federal Reserve aims for a 2% target for Personal Consumption Expenditures (PCE), with core PCE 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. The primary driver of inflation has been the shelter sector, which has taken longer to stabilize than anticipated. However, UBS analysts have observed signs that this data is finally shifting, which could help to constrain overall inflation in the months ahead.
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 has made it less likely that another substantial cut will occur in the near term.
UBS strategists maintain that their base case anticipates a 25-basis-point cut at the two remaining meetings this year, followed by a shift to a quarterly pace in 2025. The September dot plot revealed that nine out of 19 Federal Reserve participants expect fewer than 50 basis points of additional cuts in 2024. Recent public comments from Fed officials suggest a growing sentiment that it may be appropriate to hold policy steady at the upcoming November meeting.
Market expectations currently price in approximately 1.7 rate cuts by December, indicating a 30% chance that the Fed may opt to skip a cut this year. UBS believes that even if a cut is skipped, it would not significantly alter the broader trajectory of monetary policy, as the Fed appears to be moving toward a neutral stance by 2025.
The interplay between labor market dynamics, inflation trends, and Federal Reserve policy is shaping the economic landscape in the United States. While the labor market shows signs of strength, the mixed sentiment among businesses and consumers raises questions about the sustainability of this growth. The Fed's approach to interest rates will be critical in navigating these challenges, as it seeks to balance economic growth with inflation control.
The potential for AI-driven productivity gains could provide a silver lining in the long-term inflation outlook. This evolving scenario underscores the importance of closely monitoring economic indicators and Fed policy decisions, as they will have significant implications for both traditional finance and the broader market environment.
The coming months will be pivotal in determining the trajectory of the U.S. economy, as stakeholders remain vigilant in their analysis of labor market trends, inflation data, and monetary policy shifts.