As the largest economy in the world approaches recession, UBS projects that the U.S. Federal Reserve will reduce interest rates by as much as 275 basis points in 2024—nearly four times the market average.

The Swiss bank stated that while the U.S. economy has been resilient until 2023, many of the same challenges and risks still exist in its 2024–2026 prognosis for the economy, which was released on Monday. However, “fewer of the supports for growth that enabled 2023 to overcome those obstacles will continue in 2024,” according to the bank’s economists.

According to UBS, the Federal Open Market Committee would lower rates “first to prevent the nominal funds rate from becoming increasingly restrictive as inflation falls, and later in the year to stem the economic weakening” in 2024 as a result of disinflation and rising unemployment.

The FOMC implemented a series of 11 rate hikes from March 2022 to July 2023, raising the target range of the fed funds rate from 0% to 0.25% to 5.25% to 5.5%.

Since then, the central bank has maintained its position, leading most markets to believe that rates have peaked and to start making predictions about the number and timing of further reductions.

But Fed Chair Jerome Powell stated last week that he was “not confident” the FOMC has done enough to bring inflation back to its target of 2% over the long run.

According to UBS, real GDP grew by 2.9% from the start of the year to the end of the third quarter, even in the face of the most aggressive cycle of rate hikes since the 1980s. But since the FOMC meeting in September, rates have increased and the stock market has been under pressure. According to the bank, this has rekindled growth fears and indicates that the economy is still “not out of the woods.”

“The expansion bears the increasing weight of higher interest rates. Credit and lending standards appear to be tightening beyond simply repricing. Labor market income keeps being revised lower, on net, over time,” UBS highlighted.

“According to our estimates, spending in the economy looks elevated relative to income, pushed up by fiscal stimulus and maintained at that level by excess savings.”

The bank predicts that while family savings are “thinning out” and balance sheets appear less solid, the upward pressure on growth from the fiscal impulse in 2023 will subside the following year.

“Furthermore, if the economy does not slow substantially, we doubt the FOMC restores price stability. 2023 outperformed because many of these risks failed to materialize. However, that does not mean they have been eliminated,” UBS said.

“In our view, the private sector looks less insulated from the FOMC’s rate hikes next year. Looking ahead, we expect substantially slower growth in 2024, a rising unemployment rate, and meaningful reductions in the federal funds rate, with the target range ending the year between 2.50% and 2.75%.”

According to UBS, the economy will collapse by 0.5 percentage points by the middle of the next year, with GDP growth in 2024 falling to only 0.3% and unemployment reaching almost 5% by the end of the year.

“With that added disinflationary impulse, we expect monetary policy easing next year to drive recovery in 2025, pushing GDP growth back up to roughly 2-1/2%, limiting the peak in the unemployment rate to 5.2% in early 2025. We forecast some slowing in 2026, in part due to projected fiscal consolidation,” the bank’s economists said.

The beginning conditions are “much worse now than 12 months ago,” according to Arend Kapteyn, global head of strategy research at UBS, who spoke with CNBC on Tuesday. This is especially true given the “historically large” quantity of credit that is being removed from the U.S. economy.

“The credit impulse is now at its worst level since the global financial crisis — we think we’re seeing that in the data. You’ve got margin compression in the U.S. which is a good precursor to layoffs, so U.S. margins are under more pressure for the economy as a whole than in Europe, for instance, which is surprising,” he said.

The “massive gap” between real incomes and spending, which implies there is “much more scope for that spending to fall down towards those income levels,” is another point made by Kapteyn. She also pointed out that private payrolls, excluding health care, are growing at almost zero percent and that part of the fiscal stimulus for 2023 is ending.

“The counter that people then have is they say ‘well why are income levels not going up, because inflation is falling, real disposable incomes should be improving?’ But in the U.S., debt service for households is now increasing faster than real income growth, so we basically think there is enough there to have a few negative quarters mid-next year,” Kapteyn argued.

In many economies, two quarters in a row of real GDP decrease are considered to be a recession. A recession in the United States is described as “a significant decline in economic activity that is spread across the economy and that lasts more than a few months” by the Business Cycle Dating Committee of the National Bureau of Economic Research. This considers a comprehensive analysis of the labour market, incomes, industrial production, consumer and business spending, and labour market conditions.

The market consensus for rates and growth is significantly exceeded by UBS’s projections. According to Goldman Sachs, the US economy will grow by 2.1% in 2024, faster than that of other industrialised nations.

Head of global FX, rates, and EM strategy at Goldman Sachs Kamakshya Trivedi told CNBC on Monday that the Wall Street behemoth was “pretty confident” in the forecast for U.S. growth.

“Real income growth looks to be pretty firm and we think that will continue to be the case. The global industrial cycle which was going through a pretty soft patch this year, we think, is showing some signs of bottoming out, including in parts of Asia, so we feel pretty confident about that,” he said.

Referring to the recent dovish remarks made by Fed officials, Trivedi continued, “monetary policy may become a bit more accommodative as inflation gradually returns to target.”

“I think that combination of things — the lessening drag from policy, stronger industrial cycle and real income growth — makes us pretty confident that the Fed can stay on hold at this plateau,” he concluded.

(Adapted from CNBC.com)