UBS economists are not, it should be said, predicting an asteroid to hit the planet.
But their view on interest rates is wildly different than the rest of Wall Street and reflects a gloomy forecast for the U.S. economy next year. They expect the federal funds rate, now between 5.25% and 5.5%, to fall all the way to 2.75% by the end of next year, and then further down to just 1.25% in the first quarter of 2025.
There isn’t really any other firm even close. TD Securities expects rates to fall to 3.5% by the end of next year and then to 3% in the first quarter of 2025. The median, per Bloomberg News data, is for rates to fall to 4.5% at the end of 2024 and further down to 4% in the first quarter of 2025. There are a few firms, notably Bank of America and Goldman Sachs, forecasting the Fed rate to be above 5% by the end of 2024, as does the Federal Open Market Committee itself.
The UBS team led by Jonathan Pingle say the big boost from COVID-era savings is wearing off. “Households’ excess savings are thinning out and balance sheets look less solid with every passing month,” they say. The people who still do have savings are upper-income households, who are likely to treat excess savings as wealth rather than income, “suggesting a much slower spend out rate that adds little to consumption.”
Credit is tightening too — with credit-card balances rising, and banks lifting the rates they charge from 14.5% to 21.2% since the start of the hiking cycle. The share of personal interest payments in personal income has climbed more than 1 percentage point since the start of 2022, close to multi-decade highs. Income growth, they say, will slow, as the nation is already at full employment.
The business side of the economy doesn’t look very strong either, they say. Rig counts have been contracting, manufacturing output net of strikes has fallen over the past year, and temp help employment has fallen sharply, while forward-looking data on expansion looks weak and inventories are relatively high. “Those features—weak new orders and lack of inventory tailwind—imply a vulnerable business sector of the economy. In addition, credit is also tightening for businesses,” they say.
Okay, but does that add up to massive rate cuts? Here’s the UBS forecast on inflation — they say the Fed’s preferred PCE price index will fade gradually over the next year, with the core PCE falling to 1.8% by the end of the fourth quarter. That’s not much below the Fed’s 2% target though it is much lower than other Wall Street forecasts.
The UBS team say that’s important because the Fed is calibrating its rate policy to real — that is, inflation-adjusted, rates. They note Chair Jerome Powell said in September “the time will come at some point, and I’m not saying when, that it’s appropriate to cut. Part of that may be that real rates are rising because inflation is coming down.” According to UBS, that time will come in March, when the spread between the nominal Fed rate and core PCE inflation will be nearly 2.5 percentage points.
That’s still not enough however to get the Fed rate down to 2.75% by the end of the year. UBS also thinks the unemployment rate — already a 0.5 point above its cycle low — will steadily rise through the year, reaching 4.9% in the fourth quarter of 2024 and 5.2% at the end of the first quarter of 2025.
“A rising unemployment rate and labor market slackening tend to imply more disinflationary forces to come. We expect retaining very restrictive policy would be pretty untenable in the face of outright job loss. If inflation is at or below 2.0% and the unemployment rate is rising as we expect, even a so-called Taylor Rule would suggest rate cuts that are both swift and deep, as shown above,” they say.
The yield on the monetary policy-sensitive 2-year Treasury
has been holding above 5%, though it’s down by nearly a quarter point since its peak in mid-October. The S&P 500
has gained 15% this year.