New US growth data and the path to lower interest rates

Bumper GDP figures from the US economy today kept investors on edge amid expectations that interest rates will stay high throughout 2024.

The US economy expanded at an annualised rate of 4.9% in the third quarter, the strongest showing since the end of 2021 and well ahead of the 4.3% forecast and 2.1% growth the previous quarter.

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A sharp acceleration in consumer spending underpinned the result, but these figures are backward-looking, and traders expect the impact of much higher borrowing costs to act as a brake on activity in the coming quarters.

This gives the Federal Reserve room to continue its wait-and-see approach when policymakers meet next week, particularly with a 10-year Treasury yield of near to 5% doing much of their work.

They will also be encouraged by separate figures published today showing their favoured measure of PCE inflation had slowed to an annualised rate of 2.4% in the third quarter, down from 3.7% in the previous quarter and versus expectations of 2.5%.

The S&P 500 index fell 0.6% in the first 30 minutes of today’s session, extending a poor run after the US benchmark yesterday retreated 1.4% to its lowest level since June. As well as the impact of a 16-year high for long-term bond yields, there’s been a negative reaction to this week’s run of results from mega-cap stocks including Alphabet Inc Class A (NASDAQ:GOOGL).

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The FTSE 100 index, whose leaning towards “value” stocks has offered some protection during the current market downturn, reached mid-afternoon about 45 points lower.

The selling came as the European Central Bank (ECB) today kept rates on hold for the first time in over a year. The pause after 10 consecutive hikes to a 22-year high of 4.5% follows recent signs that the EU economy contracted during the third quarter.

Deutsche Bank chief European economist Mark Wall said: “The ECB says that patience is now key. Only by keeping rates at the current restrictive level for sufficiently long can it be sure that inflation will get back to target. The question is, how long is sufficiently long?”

The Federal Reserve decision is due on Wednesday, followed the next day by the Bank of England when UK rates are set to stay at 5.25% for the second meeting in a row.

Investors on both sides of the Atlantic will be looking for clues on the outlook for rates in 2024, particularly given that high borrowing costs are now being felt through weaker corporate earnings and consumer demand.

This has been particularly noticeable after a flurry of profit warnings and downgrades to guidance in the FTSE 250 index, which has fallen by more than 11% since mid-September.

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Capital Economics sees UK rates staying at their current level until November 2024, later than the City consensus of September and longer than the typical gap of 10 months between the monetary policy committee’s last rate hike and first rate cut.

The consultancy said today: “First, the effects of higher interest rates are filtering through the economy more slowly than in the past and are also being cushioned by the lingering effects of the pandemic. That suggests that rates need to be higher for longer to have the same dampening effects on activity, wage growth and inflation.

“Second, with the inflation expectations of businesses and households still higher than before the pandemic, we think wage growth and core inflation will fall only slowly even as activity weakens.

“Third, the Bank knows that high inflation has dented its credibility so it will want to be absolutely sure that inflationary pressures are consistent with the 2% inflation target before cutting rates. It’s likely to err on the side of policy being too tight than too loose.”

Capital Economics expects interest rates down to 3% by the end of 2025, based on a mild recession creating more spare capacity than the City currently expects.