Investors look forward to Federal Reserve rate cuts next year, but experts warn that it could signal a slowing economy.
Amid falling inflation and the Fed’s reluctance to increase its benchmark rate further, investors are increasingly anticipating a reduction in interest rates in 2024. According to the CME FedWatch tool, markets are pricing in a 95% chance that rates will be lower than their current level by next December. This optimism was fueled by Tuesday’s inflation report, which showed a rise of 3.2% in October, below the expected 3.3%.
Former PIMCO chief economist Paul McCulley believes this development is a “gamechanger” and suggests that the Fed will now declare that its policy is sufficiently restrictive, marking a significant shift in approach.
However, while markets hope that a Fed rate cut will trigger a bullish rally in stocks, experts caution that any policy loosening would likely be in response to a slowing economy, and deep cuts could result from an outright recession. Moreover, JPMorgan’s chief market strategist estimated that stocks could drop as much as 20% in the event of a downturn.
Deutsche Bank strategists noted that the Fed has slashed interest rates before a recession in five of the last 10 downturns, suggesting that rate cuts are often a sign of impending economic problems. UBS also warned that rates could be slashed by 275 basis points as the economy heads into a recession in the middle of next year.
Economic indicators have already pointed to a slowdown, with GDP growth expected to reach around 2.2% this quarter, down from 4.9% last quarter. Retail spending declined for the first time since March, and the labor market added only 150,000 jobs in October, all suggesting that US consumers may be starting to lose steam.
The cooling labor market is a particularly worrying sign, as it could trigger the Sahm rule, a highly accurate recession indicator created by former Fed economist Claudia Sahm. She noted that while the US is not yet in a recession, it’s getting closer to the flashing red indicator, with no guarantee that a recession can be averted.
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