Like a child’s seesaw, the equity market moves back and forth, anticipating either recession or soft landing, rate cuts or not. Not only is this a year of market debate, but one of presidential and congressional elections.
Much of the controversy surrounding both the level and direction of markets and interest rates in the U.S. derives from the current strength of the economy, with low unemployment at approximately 3.7% and GDP growth averaging 2-3% per quarter despite interest rate hikes throughout 2023 by the Federal Reserve. Many observers had expected both consumer demand and overall market performance to decline in 2023 because of these interest rate increases to combat inflationary pressures. Instead, the market rallied at the end of 2023 to record levels. In short, we have a mixed bag of factors, leading to many different outlook scenarios for 2024 and beyond.
The Case For A ‘Soft Landing’
This view expects the economy to avoid a recession in 2024 despite higher interest rates due to a continuation of near “full employment” and declining inflation, which should lead to interest rate cuts by the Fed.
But controversy continues, with Fed Fund futures pricing in cuts to 3.75%-4% by December 2024 while the Fed’s Open Market Committee projects three cuts of 25 basis points each from 5.25%-5.50%, to about 4.5%-4.85% by December 2024.
Also in doubt is the timing of these cuts—with the futures market pricing in cuts beginning in March; others believe the Fed will not begin to reverse course until later in the year, to see what effect 2023 interest rate increases have had. Inflationary levels have begun to decline toward the Fed’s 2% target. But, is this a trend? Some believe labor markets are tightening, which could lead to inflationary wage pressure in 2024. The latest U.S. Bureau of Labor Statistics Employment Situation Report had net payrolls growing by 165,000 workers on average and the average work week coming in slightly lower at 34.3 hours.
Increasing wage rates, especially in factories following auto workers’ strikes and writers’ strikes and others, have pushed inflation, as has pent-up consumer demand following the pandemic. With so many unique variables to consider, forecasting in 2024 is especially complex. Supply chains have improved following the pandemic-induced outages and so many consumer goods prices have declined. But food and housing prices remain high.
Perhaps the strongest elements of the bull case for a “soft landing” this year derive from a two-fold economic boost, from productivity gains and large scale project spending by the government on infrastructure renewal. It seems the economy is on the verge of a potentially massive productivity boost from technological innovation, led by artificial intelligence. This could rival productivity increases from the deployment of personal computers (PCs) in the 1990s and the internet and cell phones in the 2000s. If growth is largely the result of productivity gains, then inflation can be held in check, giving the Fed the flexibility to cut rates sooner. Spending on infrastructure should enable wage and employment growth for the remainder of the decade in sectors such as the electrical grids, bridges, highways, and tunnels and this could lead to widespread innovation in technology deployment.
Although it is tricky to get all the variables in place in a timely fashion, these variables could enable a soft landing and a positive outlook for the economy.
The ‘Bear’ Case For A Recession In 2024
The bear case stems from the fact that interest rates and inflation remain at higher levels. Both have had a dampening effect on demand in some sectors, including housing. Wage levels are higher too, while employment levels, at 3.7%, are very high historically. Will this lead to wage-push inflation? If so, the Fed will postpone easing and the markets will reprice downward. If Fed rate cuts are delayed, despite the market pricing them in, equilibrium will be restored at possibly much lower levels on the Dow and S&P.
Then, there’s the federal deficit and congressional intransigence on a budget approval. Both are potentially inflation-fueling variables.
Then there’s the dual threats of both U.S. debt downgrades and a decline in the dollar, potentially increasing inflationary pressure as well.
Finally, there is the overarching serious threat of expansions of wars in Ukraine and the Middle East and U.S. participation, which is impossible to predict.
In short, markets hate uncertainty because it is so difficult to price assets. We have plenty of uncertainty now.
Audrey Snell is assistant professor of financial planning at The American College of Financial Services.