Since the beginning of 2024, investors have been primarily focused on when the Federal Reserve will start cutting interest rates.
March initially seemed the right time for a rate cut, but a string of unfavorable economic data pushed hopes for June. Now, for the same reasons, the first rate cut this year may not come until December, if at all, although UBS economists still expect a cut in September.
But analysts at UBS said the investment outlook really depends less on when the Fed will start cutting rates and more on the path and destination it takes afterwards.
Analysts noted that they are up nearly 15% year to date, even as the market price for 2024 cuts has fallen from about 7% to less than 2% now.
“What's important is that economic growth and profits are beating expectations,” they explained. “Whether the first rate cut comes in September or December is unlikely to make a big difference to either over the next 12 months.”
“Debates around the pace, size and final level of rate cuts are therefore expected to be at the forefront of the agenda this summer and are also highlighted in our second half outlook,” the analysts added.
This reflects the consensus view on macroeconomic conditions for the remainder of 2024, with most investors expecting modest GDP growth and inflation, low recession risks, and a realistic range of zero to two rate cuts. However, analysts note that the range of possible outcomes for growth, inflation, fiscal policy, and Fed rate cuts is much wider for 2025 and beyond.
Focusing specifically on interest rate developments, the discussion is relevant to the investment outlook for three main reasons, the report said.
First, changes in the 10-year Treasury yield closely reflect changes in market expectations for the neutral federal funds rate, suggesting that changes in expected Fed rate cuts can have a similar impact on the 10-year Treasury yield.
Second, the debate over the neutral federal funds rate (r*) and how tight current monetary policy is remains important: opinions are widely divided, with some arguing that policy is not tight enough and others arguing that the neutral rate is around 3%.
“The resilience of the U.S. economy currently favors the former view, but a sharp slowdown in growth could tilt the balance toward the latter,” the analysts wrote.
Finally, the Fed has not provided a clear framework for the path of rate cuts, creating potential volatility in the markets.
The Fed's “dot plot” suggests steady rate cuts until the federal funds rate reaches 3% to 3.25% by December 2026, but it remains unclear how the Fed will respond to deviations from its growth and inflation forecasts.
As economic conditions change, expectations of rate cuts may fluctuate significantly, which could contribute to market volatility.