The key economic question for 2024 is how to think about the interest rate cuts we’re likely to get from the Federal Reserve. Are they good news for the economy as borrowers catch a break, or a sign of impending recession as they were in 2001 and 2007?
There’s still considerable disagreement about the timing and extent of monetary easing given the recent inflation shock, but Fed policymakers clearly signalled in the minutes of their last meeting, released Wednesday, that rate cuts should begin at some point this year.
An important consideration in this discussion is how “out of sync” the post-pandemic economic recovery has been so far. Whereas the 2001 and 2007 rate cuts came at the end of an investment and/or borrowing binge, policy easing this year would come after rate-sensitive and cyclical parts of the economy have been in a slump for roughly two years. Those areas were already set to rebound somewhat in 2024 — the added boost from rate cuts could turn that recovery into something closer to a boom.
The first and most important area affected is, of course, the housing market. Homebuilders have thrived in an environment of high interest rates, enticing buyers by offering to lower mortgage costs, but the limited supply of preowned homes on the market froze resale transactions. Existing home sales in recent months slumped to levels seen following the collapse of Lehman Brothers Holdings Inc. and the bursting of the subprime-mortgage bubble in 2008.
Lower home-loan rates should help unfreeze the resale market, provide an additional boost to builders, and even give some homeowners the ability to finance renovations and add-on projects that were put on hold while interest rates were rising and recession fears elevated.
Inflation-adjusted residential investment looks poised to grow again, year over year, recovering from the deeply negative levels of late 2022 and early 2023. That’s the pattern we’ve historically seen coming out of economic recessions in the US. By spring, the housing market should feel like it’s growing again for the first time since rate hikes began.
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A rebound in housing should help shake the manufacturing sector out of its extended malaise. The slump began when consumers shifted their spending from goods to activities like travel and leisure in the spring of 2022. That left companies oversupplied; they spent multiple quarters working down inventory levels rather than restocking their shelves.
High inflation, rising borrowing costs and low levels of new orders weakened business confidence. The ISM Manufacturing Index, a widely followed measure of sentiment, has been contracting for 14 consecutive months — a worse outcome than the 2008 recession produced — though it’s finally showing signs of stabilizing. A pickup in factory orders over the next few months should push the gauge back into expansion territory.
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The final piece of the puzzle is banks, which should start to loosen lending standards after a cautious 18 months. Lenders were building their capital levels all last year and, as I noted in November, some are beginning to discuss when they will be in a position to deploy rather than accumulate cash. The recent sharp declines in longer-term interest rates should bring those timelines forward by repairing some of the damage done to their portfolios of US Treasury and mortgage-backed securities.
Already, the net share of banks tightening standards for medium and large businesses declined in the third quarter from the previous three months, according to the Fed’s Senior Loan Officer Survey. I’d expect that to become an overall loosening of standards by the second or third quarter, particularly since much of the tightening was due to the impairment of securities that are fundamentally high quality, though hurt by rising interest rates, rather than loan losses associated with recessions.
Some observers have pointed to 1995 and 2019 as other years when the Fed employed tactical rate cuts that turned out not to signal recession. For me, the current setup most closely resembles 1983, when interest rates were elevated to contain inflation, which held back credit-sensitive economic growth. When inflation eased, allowing borrowing costs to fall, that growth was unleashed in spectacular fashion.
Credit and investment haven’t been as restrained over the past two years as they were in the early 1980s, but the overall dynamics are similar. The extent to which we get a pickup in credit- and investment-driven growth in 2024 will determine whether we get something like a soft landing or an environment much hotter than that.
