Investing.com -- Further rate cuts from the Federal Reserve should help sustain the US economic growth, according to UBS strategists.
Recent economic data has shown unexpected strength, particularly in the labor market. September's report revealed stronger payroll and wage growth, alongside a drop in the unemployment rate.
While wage growth has eased since its 2022 peak, it remains higher than any point in the decade before the pandemic. However, despite this strength in labor data, business and consumer surveys have reflected weaker sentiment.
"With help from Fed rate cuts, we expect growth to continue at a good pace in the quarters ahead," UBS strategists said in a Monday note.
Meanwhile, inflation, which surged during the pandemic, has gradually moderated over the past two years. The Federal Reserve’s target is 2% for Personal Consumption Expenditures (PCE), with core PCE—excluding food and energy—seen as a better indicator of underlying inflation trends.
In August, PCE inflation slowed to 2.2% year-over-year, and UBS expects a further decline to 2.1% in September, helped by falling gasoline prices.
"Shelter remains the biggest driver of inflation and has taken longer to slow than we expected, but it does appear that the data have finally turned, which should help constrain overall inflation in the months ahead," they noted.
Despite solid wage growth, the strategists believe inflation may remain slightly above the Fed's 2% target in the medium term. Still, they see the potential for AI-driven productivity gains to lead to lower inflation in the long term.
The downside risks in the labor market that emerged earlier this year gave the Fed a reason to start its rate-cutting cycle with a larger-than-expected 50-basis-point reduction in September. However, the stronger-than-expected data makes it unlikely that another 50bps cut will occur.
"Our base case remains that the Fed will cut by 25bps at the two remaining meetings this year, then slow to a once-per-quarter pace in 2025,” strategists said. “We do see some risk that the Fed will decide to skip a cut this year.”
The September dot plot showed that nine of the 19 participants expect fewer than 50bps of additional cuts in 2024. Recent public comments also suggest some officials believe it might be appropriate to hold policy steady at the upcoming November meeting.
Markets are currently pricing in around 1.7 rate cuts by December, implying a 30% chance of a skipped cut this year. UBS believes a skip wouldn’t alter the broader trajectory, with the Fed moving toward a neutral policy stance in 2025.