Gloomy Forecast for U.S. Economy: UBS Economists Take Different Stance on Interest Rates

UBS economists have presented a strikingly gloomy forecast for the U.S. economy next year. While they are not predicting an asteroid collision with the planet, their view on interest rates sets them apart from the rest of Wall Street.

According to their analysis, the federal funds rate, which currently stands between 5.25% and 5.5%, is expected to plummet to 2.75% by the end of next year. Furthermore, it is projected to decline even further to just 1.25% in the first quarter of 2025.

No other firm even comes close to UBS’s standpoint. TD Securities, for instance, anticipates rates to fall to 3.5% by the end of next year and then to 3% in the first quarter of 2025. The median prediction based on Bloomberg News data suggests rates will decrease to 4.5% by the end of 2024 and further decline to 4% in the first quarter of 2025. While some entities, including Bank of America and Goldman Sachs, share the Federal Open Market Committee’s forecast of a Fed rate above 5% by the end of 2024, they are in the minority.

Led by Jonathan Pingle, the UBS team explains that the significant boost to savings brought about by the COVID-19 pandemic is diminishing. They state, “Households’ excess savings are thinning out, and balance sheets look less solid with every passing month.” As a result, even those who still possess savings are likely to view them as wealth rather than income, leading to a slower spending rate that contributes little to overall consumption.

Furthermore, credit conditions are tightening. Credit card balances have been on the rise, and banks have raised interest rates from 14.5% to 21.2% since the hiking cycle began. The percentage of personal income dedicated to interest payments has increased by over 1 point since the start of 2022, reaching levels not seen in decades.

The UBS economists predict that income growth will slow, as the nation is already at full employment. This further underscores their pessimistic view on the state of the U.S. economy.

In summary, UBS economists are delivering a distinct outlook on interest rates that sets them apart from their peers on Wall Street. Their somber assessment reflects a weakening U.S. economy and suggests that challenging times lie ahead.

The Business Sector: A Vulnerable Economy

Recent data suggests that the business side of the economy is showing signs of weakness. Rig counts have been decreasing, manufacturing output has fallen, and temp help employment has sharply declined. Moreover, forward-looking indicators indicate a lackluster expansion outlook, while inventories remain relatively high. Analysts warn that these factors, along with weak new orders and a lack of inventory tailwind, imply a vulnerable business sector. Additionally, businesses are facing tightening credit conditions.

Inflation Forecast: Gradual Decline

While the state of the economy might point to potential rate cuts, inflation forecasts paint a slightly different picture. UBS predicts that the Fed’s preferred PCE price index will gradually fade over the next year, with the core PCE falling to 1.8% by the end of the fourth quarter. While this figure remains close to the Fed’s 2% target, it diverges significantly from other Wall Street forecasts.

Real Rates and Rate Policy

UBS emphasizes the importance of real rates in shaping the Fed’s rate policy. Chair Jerome Powell previously indicated that the appropriate time for rate cuts would come when real rates rise due to declining inflation. UBS believes this time will arrive in March when the spread between the nominal Fed rate and core PCE inflation reaches around 2.5 percentage points.

Challenging Rate Reductions

Nevertheless, even with this anticipated development, UBS does not foresee the Fed rate falling to 2.75% by the end of the year. UBS also predicts that the unemployment rate, which is already 0.5 points above its cycle low, will continue to rise. By the fourth quarter of 2024, they anticipate an unemployment rate of 4.9%, which will further increase to 5.2% by the end of the first quarter of 2025.

Disinflationary Forces and Rate Cuts

A rising unemployment rate and labor market slackening would likely result in additional disinflationary forces. UBS argues that maintaining highly restrictive policy would be challenging when job losses are imminent. In the face of inflation at or below 2.0% and an expected rise in the unemployment rate, a so-called Taylor Rule would suggest the necessity of swift and deep rate cuts.

Economic Update

Treasury Yield Analysis

The 2-year Treasury BX:TMUBMUSD02Y yield, which is closely aligned with monetary policy, has remained above 5%. Although it has experienced a slight decrease of around a quarter point since reaching its highest point in mid-October.

Stock Market Performance

Meanwhile, the S&P 500 SPX index has shown significant growth this year, with a remarkable increase of 15%.

Stay informed about the latest economic trends and market movements for informed decision-making.