US economic update: how likely is a recession and interest rate cut?

1.   What is the current state of the US economy?

The US economy has staged an impressive recovery from the pandemic. Despite the US central bank raising interest rates aggressively to combat inflationary pressures, economic output has expanded strongly, to some degree helped by fiscal stimulus. But cracks in parts of the economy under the higher rate environment are starting to show, such as through a rising unemployment rate. Questions are now being asked as to how deep these frictions are and whether they are a sign of a broader, more severe stress on the US economy.

2. How have global financial markets reacted to the risk of a downturn in the US economy?

Financial markets have been very sensitive to any signs that the US economy might be slowing. The clearest example of this was at the start of August where a soft manufacturing survey and weaker than expected employment data sparked a sharp shift in investor appetite towards lower risk assets in financial markets. Global equity markets nosedived as fears intensified over the possibility of a deep US downturn.

3. What will happen to US interest rates next?

Unlike other developed economies such as the UK and the Eurozone, the US is yet to start lowering interest rates in this cycle. We expect that to change come 18 September 2024, though. Federal Reserve Chairman Jerome Powell has hinted strongly that the committee responsible for setting interest rates is ready to lower the policy rate, but with this near confirmation, the next question is ‘by how much?’. If the committee thought that the economy was indeed slowing sharply, it might feel it appropriate to kick-start policy easing with a 'jumbo-size' cut of 50 basis-points. Although not impossible, we do not think the economic data currently points to enough of a slowdown to warrant such a move, with a smaller 25 basis-point reduction likely to be favoured. Following that, we forecast one more reduction this year, then a slow and steady path back down to 'neutral' interest rates, where monetary policy neither weighs on the economy, or stimulates it.

4. What does this mean for individuals with international investment, business or currency market exposure?

Our own expectation is that the US economy will slow over the remainder of the year, most likely stemming from weaker consumer spending, but that it will avoid a recession. Financial markets will likely continue to look for any data that suggests otherwise, meaning that spells of volatility are unlikely to be behind us. On the currency market, it has also long been our view that the dollar is overvalued, and once rate cuts turn from an expectation to a reality, there will be downward pressure on the greenback. We have already seen some of this pressure, GBP/USD recently hit $1.32, its highest level since March 2022. Our forecasts see the currency pair rising to $1.37 by end of 2025.

5. Will the US economic outlook change after the US election on 5 November?

Of course, come 5 November, all could change depending on the outcome of the US Presidential Elections. There are some differences between the economic policies of Democrat candidate Kamala Harris and Republican candidate Donald Trump, such as on corporation tax, which could spell a different path for the economy and interest rates. A further factor to consider is each candidate's approach to existing institutions; in the election campaign, Mr Trump has questioned the independence of the Federal Reserve. But it is also important to note that it is not all about who is the President. The House and Senate races also matter, as this will determine how easy it is to get bills to the President's desk to sign into law.

This article is for general information purposes only and should not be used or relied upon as professional advice. It is advisable to contact a professional advisor if you need financial advic