This Week’s Developments in the US Economy

Dovish Delay or Hawkish Hold? A Little of Both in the Current SEP

While the Fed delivered a widely expected hold this week, their quarterly Summary of Economic Projections (“SEP”) highlighted dovish projections for the economy while the Dot Plot tilted slightly more hawkish. Chair Powell’s comments in the FOMC press conference appeared nondefinitive at first, but we believe we learned more about where the Fed has confidence with respect to its inflation mandate and the health of the economy amid the steepest tightening campaign in four decades (see accompanying visual). Specifically, the Fed expects housing inflation indicators to come in over time (and acknowledged a clear lag in the data), improvements in the outlook for growth, broad-based stability in labor markets, and a negligible risk of a wage-price spiral. Markets have come in line with the Fed’s outlook for rates in 2024, pricing in three to four cuts over the course of the year (see accompanying visual), with the real debate as to whether cuts will gradually start in June versus July. While the difference of one month versus another may seem trivial, we have seen an uptick in delinquencies in debt markets, particularly the CRE CLO space, which could have meaningful implications for capital markets mid-year.

What the SEP Tells Us

Notwithstanding improvements to the outlook, there are some subtle hawkish indicators with respect to interest rates going forward. In the December 2023 SEP, the projected policy path indicated three rate cuts in 2024 in terms of the median voter, and, while the median has not changed, there is a slight hawkish tilt in the Dot Plot as the average and central tendency shifting upward in the current SEP. In the March 2024 SEP, 10 out of 19 committee members anticipated three rate cuts, with one of the ten penciling in a potential fourth cut. Most members align around the median, however, there was a slight adjustment between the December and March SEP, as one member transitioned from anticipating three rate cuts to projecting two or fewer.

Earlier in 2023, markets seem to have adopted the “higher for longer” outlook, but following the SEP release in December 2023, the market got bullish and priced in six rate cuts by year-end 2024 (see accompanying visual on the year-end implied rate from Fed Futures). However, leading up to this week’s release of the March 2024 SEP, market pricing dropped back to three cuts. This return to a "higher-for-longer" mentality likely stems from several factors, including moderating but still warm employment and wage growth, and the Fed's persistent messaging of a concern for a resurgence in inflation. And despite the potential for prolonged higher rates, many market observers see the economy averting a recession this year.

What We Learned from the March FOMC Briefing

In the latest Federal Open Market Committee (“FOMC”) meeting, the Fed continues their “wait and see” approach as they want to see inflation on a sustainable path toward the 2% target before cutting rates. In the Q&A session following this week’s FOMC meeting, Chair Jerome Powell acknowledged the housing component operating at a lag, but also expressed confidence that current housing conditions eventually will be reflected in the inflation readings. Furthermore, the committee noted an absence of emerging cracks in the labor market and further expressed no concern regarding wage growth. With measured optimism regarding the housing component of inflation, wages, and the overall labor market, the increased confidence needed to cut rates likely hinges on disinflationary readings (growing, but at a slower rate) of goods and services ex housing.

Economic Resilience Amid Market Segment Challenges

In the current cycle of interest rate hikes, the target rate has climbed by 525 basis points since March of 2022, marking the most pronounced increase observed in over four decades. Despite this aggressive tightening of monetary policy, the economy has remained resilient and has outperformed expectations in many aspects.

Looking further into 2024, while the Fed's forecast for unemployment closely aligns with that of consensus expectations, their expectations for growth as of late surpass recent consensus projections. In the December 2023 SEP, the Fed posted a 1.4% year-over-year growth forecast for year-end 2024, but the March 2024 SEP saw a meaningful upward revision to 2.1%, largely grounded in the continued strength of the labor market.

With projections of positive economic growth and a rising, but not skyrocketing, unemployment rate, many market observers are optimistic the US may sidestep a recession again in 2024, echoing the trend observed in the previous year (2023 was full of recession calls). That is not to say that we do not anticipate some pain and distress emerging. Notably, CRE CLOs, bundling floating-rate, short-term property loans, have faced challenges in the past couple of months due to the prevailing high-interest rate environment. Diminished property values have made loan repayment difficult for some borrowers. Consequently, the share of delinquent CRE CLO loans is rising—according to one measure posting 7.4% in February, four times higher than levels recorded just seven months ago, underscoring the mounting strain within this sector.

With rates holding steady and loan maturities coming due, we anticipate capital markets activity is poised to accelerate as a result.