Investment Review & Outlook – October 2024

With interest rates starting to come down against a backdrop of declining inflation, our outlook for US economic growth over the next 6 to 12 months is one of cautious optimism. Our view is tempered by several critical factors, primarily regarding the health of the US consumer, the driver of the majority of economic activity in this country. Reasonable levels of consumer spending and confidence, along with a healthy labor market, will go a long way towards the Fed achieving a soft landing whereby inflation remains controlled without the economy tilting into recession.

Declining Inflation Yet Elevated Prices

The decline in inflation to 2.5%, which is well within range of the Fed’s 2% target, is a positive sign, indicating that the Fed’s measures to combat inflation are having the desired effect. This should help stabilize consumer purchasing power and confidence. However, while the price increases of durable goods have moderated significantly, inflation in other areas, particularly housing, remains more persistent.

Inflation has affected both consumers and businesses, weakening consumer demand and delaying investments and inventory replenishments. It is important to note that declining inflation refers to a reduction in the rate at which prices increase, not an overall decrease in prices. Consumers still feel the financial strain because the price level of goods and services today is much higher compared to previous years.

The Fed’s September Rate Cut

The Fed’s recent cut of the fed funds rate aims to stimulate the economy by reducing borrowing costs, which helps to alleviate financial pressure on consumers and businesses. The Fed’s decision to cut rates by 50 basis points, a more aggressive move than the anticipated 25 basis points (one basis point is equal to 1/100th of a percent), is an effort to stay ahead of any potential economic slowdown.

This first cut to the fed funds rate since March 2020, brought rates down to a range of 4.75% to 5.00%, from the 5.25% to 5.50% level that existed since last July, the highest since 2001. As long as inflation appears to be under control, we expect the Fed to proceed with implementing a series of rate cuts through the remainder of 2024 and into 2025. The expectation is for additional 25 basis points reductions at each of the upcoming November and December meetings. The Fed’s most recent “dot plot” of expected rates indicates a fed funds target of 3.375% by the end of 2025.

Fed Chairman Jerome Powell has noted that the economy is in good shape, and the aggressive 50 basis point move is to allow for solid growth and a steady labor market, with inflation trending lower. “We’re trying to achieve a situation where we restore price stability without the kind of painful increase in unemployment that has come sometimes with disinflation,” he said in the recent post-meeting press conference. Powell added that investors should take the 50 basis point rate cut as a sign of the Fed’s “strong commitment” toward achieving that goal.

A Word About US National Debt & Fiscal Policy

The US federal debt as a percentage of gross domestic product is at 120%, an all-time high, and rising debt service costs are a concern. The national debt now surpasses $35 trillion and the federal government has paid over $1 trillion in gross interest payments on its debt for fiscal 2024. For the first time, the US is spending more on debt interest than defense.

The significant amount of the national debt could limit the government’s future ability to stimulate the economy through additional spending measures, as it did during the Covid epidemic and the financial crisis of 2007 to 2009. Additionally, in the run up to the November election, both political parties are making promises that could increase spending and overall debt levels. Excessive spending and debt accumulation have long-term economic consequences, as would a shift in global market sentiment regarding the value and perceived safety of US Treasuries.

Consumer Spending & Behavior

Consumer willingness to spend is a prime driver of US economic growth. In the past several years, labor market strength, including solid wage growth, combined with a post-pandemic sentiment of having lost time during Covid-19, has contributed to a healthy appetite for consumer spending. However, there are signs of financial strain in the amount of consumer debt accumulated, particularly for consumers at lower income levels.

While the inflation rate is declining, the cumulative effects of past inflation continue to affect consumer sentiment and spending patterns. There is evidence of consumers trading down to lower-cost alternatives, such as generic store brands, which is helping to moderate inflation in certain sectors. Credit card debt has spiked, indicating that consumers are relying more on credit to manage expenses, with US consumer credit card debt recently surpassing $1 trillion. Declining interest rates may provide some relief for consumers with credit card balances.

A decline in interest rates means mortgage rates also move lower, which traditionally has stimulated demand in the housing sector, adding to economic growth. With current rates in the 6% range, and the average rate on an outstanding mortgage below 4%, it likely will take several more rate cuts before potential sellers would be willing to give up their current mortgages, many of which are long-term, fixed-rate loans. At the same time, buyers may delay purchasing homes in anticipation of further rate cuts.

Employment & Wage Growth

The labor market is another critical factor for economic growth. The Fed can shift its attention, which has focused on tempering inflation, to the labor market. Current employment trends indicate a softening labor market, with a ratio of job openings on par with job seekers. This ratio is notable when compared to post-pandemic levels when there were nearly two job openings for every job seeker. Companies are not hiring across the board, but instead are focusing on retaining current employees and improving productivity.