Equity | Investment Insight
December 19, 2023
2024 Outlook: What’s Next After the “Fed Pivot”?
The “Fed pivot” in December to a dovish stance underscores the rapidly shifting outlook for both growth and inflation. Going into 2024, we still see upside risks to inflation, downside risks to growth, and expect rates to stay higher and for longer than the rest of the market does. In this paper, Chief Economist Torsten Slok discusses the implications for corporate growth, banking, consumer spending, and financial markets.
Key Takeaways
The members of the Federal Reserve Open Market Committee (FOMC) “pivoted” to a more dovish stance in their last meeting of the year on December 13, holding rates steady and signaling that the inflation outlook has improved more quickly than anticipated. They also suggested three potential rate cuts in 2024.
- The “Fed pivot” underscores the rapidly shifting outlook for both growth and inflation. Going into the new year, we still see upside risks to inflation and downside risks to growth. Because:
- Despite signaled Fed rate cuts in 2024, we expect interest rates to stay higher and for longer than the rest of the market does. We arrive at our thesis through a combination of cyclical and secular drivers, including still-tight Federal Reserve monetary policy, higher borrowing needs by the US Treasury, the loosening of yield-curve control policy in Japan, and reduced buying and diminished inventory of US debt held by China and others.
- Two major factors driving consumer spending are largely unrelated to current Fed policy: Households are running out of excess savings and student-loan payments are restarting. The combination of these two dynamics increases the odds of a meaningful slowdown in consumer expenditures, a key driver of US growth.
- We see many signs that the Fed’s rate hikes are working to cool off the economy. Consumers are already feeling the pinch, with increased delinquencies in both credit-card debt and auto loans. Similarly, a corporate default cycle has started, and employment is beginning to soften. Finally, bank-loan growth has been slowing sharply in recent months.
- Despite the Fed’s aggressive tightening campaign, inflation remains above the central bank’s 2% annual target. We’ve long argued that rates will stay higher and for longer than the market expects. But, if above-target inflation persists, they may go higher yet.
- All that said, we do not entirely discount the possibility of upside economic surprise. This idiosyncratic economy has defied consensus predictions for some time now, and it may continue to do so. A soft landing is not out of the question.
The implications for capital markets?
- We believe private credit offers an attractive opportunity today given higher yields in general and on senior secured debt in particular—allowing investors to boost income generation in their portfolios with downside protection.
- Opportunities in private equity are likely to continue to emerge among potential distressed companies that come along with the combination of slowing growth and high rates. Moreover, we see opportunities in assets that can offer some level of inflation protection, such as infrastructure.
- In real assets, particularly real estate, we see more compelling risk-adjusted return opportunities in credit than in equity at this stage of the economic cycle.
- Public equities are as unappealing as they have been in 20 years due to stretched valuations. Public bonds—with risk-free yields on 10-year Treasuries hovering around 4.0% as of this writing—appear attractive to investors interested in “locking” higher rates in their fixed-income portfolios. That said, attention to duration risk remains warranted.
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Equity | Investment Insight
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The buoyant demand for corporate debt that propped up primary markets this year came alongside pockets of distress in the riskier parts of the market. We expect this divergence to persist through 2024. In this outlook, we’ll explore the bifurcation in the market, investment themes—from AI to elections—in opportunistic credit, the vanishing liquidity premium in investment grade debt, and the relative value of BDC’s unsecured debt.
While the Fed’s rate hikes have reigned in growth, especially among over-levered consumers, corporates, and banks, the easing of financial conditions since the “Fed pivot” in December continues to offset the effect of higher rates. For the rest of 2024, we expect economic growth to be higher than consensus and inflation to stay above the Fed’s target. We see no Fed cuts in 2024.
