Over the past two years, the Federal Reserve has increased the federal funds rate in an effort to stabilize prices. At its December 12-13 meeting, the Fed is expected to maintain its policy rate within the range of 5.25% to 5.5%. Currently, the Fed is facing a delicate balance between two risks: if they move too slowly in reducing rates, it could trigger a recession, leading to significant job losses for millions of people. Conversely, easing rates prematurely could result in inflation surpassing 3%, which is inconsistent with the Fed’s policy goal of 2%. The official release from the meeting is unlikely to include any discussion about the expected timing of rate cuts.
The current outlook appears positive due to easing inflation and wage pressures. Factors such as declining oil prices and rents have contributed to this reduction in inflation. Core inflation, which excludes food and energy prices, registered at 2.5% annually over the last six months through October, down from 4.5% over the preceding six month period. These reduced price pressures are instrumental in lessening expectations of inflation, and the decrease in wage pressures alleviates concerns regarding a potential wage-price spiral.
Federal Reserve Chairman Jerome Powell will continue to signal a willingness to increase rates if inflation proves to be sticky or moves even higher. This is all he can do to counter the growing market sentiment around the direction of monetary policy. Market participants have already priced in a nearly 60% probability of a rate cut during the Fed’s meeting in March, with expectations of a reduction in rates by nearly 150 basis points by the year’s end. The most telling aspect will be the official rate projections unveiled on Wednesday following the meeting.
In setting a forward-looking view for the direction of monetary policy, the Fed will need to navigate potential risks. Two significant looming concerns revolve around the pending rollover of corporate debt that was acquired at historically low interest rates during the pandemic. According to rating agency Moody’s Investor Service, this debt is set to start maturing in 2024, with approximately US$1.26 trillion worth of investment-grade corporate bonds due between 2024 and 2028. In total, over US$3 trillion in debt is set to rollover.
As this debt matures, the funding rate is expected to rise, but banks will be less willing to lend. This will push corporate borrowers to private credit funds for financing. Another critical policy issue on the horizon is the expiration of tax cuts enacted in 2017. Allowing corporate tax rates to reset to their pre-2017 levels is not likely to occur given the current interest rate environment.
This impending tax policy change will be a key issue to monitor in 2024 and is likely to significantly impact the macroeconomic landscape. The Fed will require sharp clarity on this issue to effectively chart its future policy course.
We expect official rate projections will make it clear the Fed is nearing the end of its rate-raising cycle and is planning to initiate rate cuts by 100 basis points around mid-2024. This will provide the Fed with some breathing room to better understand the risks associated with upcoming tax policy changes and the refinancing of corporate debt.
Housing Affordability Watch
CMI monitors the latest developments and offers insights on solutions to Canada’s housing affordability crisis
Filtering, or the decline in quality and price of properties over time, explains how homes naturally become more affordable as they age. This mechanism, not new construction, is the primary source of affordable housing in the market.
However, debates rage on its effectiveness. While some believe that increasing home construction of any kind is the key to affordability, others argue that the filtering process is too slow or that it is ineffective and instead leads to gentrification. Similar concerns are raised by those who feel it’s important to protect low density character, or express other not-in-my-backyard concerns. These debates hinder development efforts and ultimately have a detrimental impact on housing affordability.
In the latest Housing Affordability Watch, we explore the nuances of filtering theory and the hurdles making it difficult to put into practice. Read it here: Why Filtering is Key to Increasing the Supply of Affordable Housing.
Independent Opinion
The views and opinions expressed in this publication are solely and independently those of the author and do not necessarily reflect the views and opinions of any person or organization in any way affiliated with the author including, without limitation, any current or past employers of the author. While reasonable effort was taken to ensure the information and analysis in this publication is accurate, it has been prepared solely for general informational purposes. Any opinions, projections, or forward-looking statements expressed herein are solely those of the author. There are no warranties or representations being provided with respect to the accuracy and completeness of the content in this publication. Nothing in this publication should be construed as providing professional advice including investment advice on the matters discussed. The author does not assume any liability arising from any form of reliance on this publication. Readers are cautioned to always seek independent professional advice from a qualified professional before making any investment decisions.
