Coming rate cuts portend a 1980s-style economic resurgence

by Conor Sen

The key economic question for 2024 is how to think about the interest rate cuts we’re likely to get from the Federal Reserve. Are they good news for the economy as borrowers catch a break, or a sign of impending recession as they were in 2001 and 2007?

There’s still considerable disagreement about the timing and extent of monetary easing given the recent inflation shock, but Fed policymakers clearly signaled in the minutes of their last meeting, released Wednesday, that rate cuts should begin at some point this year.

The first and most important area affected is, of course, the housing market. Homebuilders have thrived in an environment of high interest rates, enticing buyers by offering to lower mortgage costs, but the limited supply of preowned homes on the market froze resale transactions. Existing home sales in recent months slumped to levels seen following the collapse of Lehman Brothers Holdings Inc. and the bursting of the subprime-mortgage bubble in 2008.

Lower home-loan rates should help unfreeze the resale market, provide an additional boost to builders and even give some homeowners the ability to finance renovations and add-on projects that were put on hold while interest rates were rising and recession fears elevated.

Inflation-adjusted residential investment looks poised to grow again, year over year, recovering from the deeply negative levels of late 2022 and early 2023. That’s the pattern we’ve historically seen coming out of economic recessions in the U.S. By spring, the housing market should feel like it’s growing again for the first time since rate hikes began.

A rebound in housing should help shake the manufacturing sector out of its extended malaise. The slump began when consumers shifted their spending from goods to activities like travel and leisure in the spring of 2022. That left companies oversupplied; they spent multiple quarters working down inventory levels rather than restocking their shelves.

The final piece of the puzzle is banks, which should start to loosen lending standards after a cautious 18 months. Lenders were building their capital levels all last year and, as I noted in November, some are beginning to discuss when they will be in a position to deploy rather than accumulate cash. The recent sharp declines in longer-term interest rates should bring those timelines forward by repairing some of the damage done to their portfolios of U.S. Treasury and mortgage-backed securities.  

Some observers have pointed to 1995 and 2019 as other years when the Fed employed tactical rate cuts that turned out not to signal recession. For me, the current setup most closely resembles 1983, when interest rates were elevated to contain inflation, which held back credit-sensitive economic growth. When inflation eased, allowing borrowing costs to fall, that growth was unleashed in spectacular fashion.

Credit and investment haven’t been as restrained over the past two years as they were in the early 1980s, but the overall dynamics are similar. The extent to which we get a pickup in credit- and investment-driven growth in 2024 will determine whether we get something like a soft landing or an environment much hotter than that.

Conor Sen is a Bloomberg Opinion columnist. He is founder of Peachtree Creek Investments.