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Writer's pictureDoug Lagerstrom

Economic Outlook | Fall 2024

The economy appears to be on track for the long awaited “soft landing”.  The Inflation rate, as measured by CPI is 2.4% and the core (excluding food and energy) rate is 3.3%.1 This lower rate has provided the Federal Reserve Board (FRB) with sufficient confidence that inflation is slowing to cut the Federal Funds Rate (FFR) for the first time since their meeting in March 2020.  It appears the economic stimulus of lower interest rates may come early enough to stave off any real economic pain from the restrictive interest rate policy they have pursued over the past couple of years.  It is worth noting that the current FFR of 4.75% is still considered restrictive.  A restrictive FFR targets inflation reduction at the risk of a recession.  An accommodative rate, on the other hand, seeks to grow the economy at the risk of inflation.  Most economists believe the neutral (neither restrictive nor accommodative) interest rate is roughly 2.75%.2

 



The US Treasury yield curve, which illustrates the current rate of interest at various maturities, has been inverted (the 2-year is higher than the 10-year rate) for the past 22 months.  “The spread between the 10-year and the 2-year Treasury yields, which grew as large as negative 108 bps in July 2023, has been inverted for the longest stretch in history”.3 (Note: 100bps equals 1%).  Historically, this condition can signal or cause a recession.  Purchasers of 10-year US Treasury Bonds are willing to accept a lower interest rate for a longer time, believing the FRB will have to lower interest rates to stimulate the economy and avoid a painful recession.  The inverted yield curve can also cause a recession because banks are discouraged from lending money.  If banks must pay more for liquid deposits than they earn lending those funds out for longer term, they lose money.  As a result, banks tend to lend less when the yield curve is inverted, which can lead to slower business expansion and a recession.

 

Are we out of the woods?

 

Maybe.  With the recent FFR cut, the yield curve has normalized.  Is it too late?  It is worth noting that the FRB cut rates 50 bps at their September meeting.  They typically have acted that aggressively (moves of more than 25bps are generally considered aggressive) during times of severe economic distress like the 2008 financial crisis, or 2020 Covid pandemic. Does the FRB think they may have waited too long?  After all, aggressive cutting in an election year is also a bit of an anomaly.  Incumbent presidents prefer lower rates to stimulate employment in the near term since the cost of those lower rates (inflation) is typically not felt for months. The FRB prefers to appear neutral and likes to avoid any appearance of being partisan and therefore typically avoids aggressive moves in election years.  It is noteworthy that the vote to cut rates 50 bps was not unanimous.  Member Michelle Bowman voted for a more moderate 25 bps rate cut.  She expressed concern that the fight against inflation may not be over.4

 

What about the Election?

 

An economic outlook also needs to consider the implications of our national election next month.  However, we do not let any political opinion influence our investment decisions and would encourage you to act the same.  We had clients who wanted to sell everything when Obama became President, and we had clients who wanted to sell when Trump won.  Experience has shown us that the leader of our country influences the economy, but often the policies promoted have less impact than other geopolitical and technological changes.  Our best general advice is to stay diversified and stay invested. (See Kumbie’s article for more on this).

 

Having said that, both candidates are promoting fiscal plans that will significantly add to our deficit and debt.  Investors appear to have the appetite for more US government borrowing for now.  If that changes in the future, we will not have many financial options.  When your annual deficit exceeds your GDP, you simply cannot grow your way out of debt.  We will likely need to cut expenditures, raise taxes, monetize the debt, or most likely carry out some form of all three.  In the meantime, our government will kick the can down the road until the public forces them to act.  The sooner the better in our opinion.

 

 

1.        Inflation Eased Slightly in September, Wall Street Journal October 11, 2024

2.        Higher Wages, More Jobs Hotter Growth.  Have we landed yet? Barron’s 10/7/2024

4.        Inflation isn’t Tamed Yet.  The Longest Fed Governor was Right, Barron’s 10/7/2024.

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