St. Louis Federal Reserve Bank President Alberto Musallam delivered a speech titled “Financial Conditions, Economic Outlook, and Monetary Policy.” This came at a special event for financial market experts at New York University.
Musallam’s speech Musallam began his speech by welcoming the audience. He expressed his pleasure to be in New York City among friends and former colleagues. He mentioned that the target range for the interest rate was reduced by 50 basis points in September.
Fed Policy The economic outlook shows that there is potential for additional cuts in coming quarters. Musallam emphasized that monetary policy remains moderately tight. The economy is now close to equilibrium with respect to inflation and employment.
Improved expectations Inflation expectations have improved significantly. In addition, the labor market has slowed over the summer. This development has given Musallam greater confidence in achieving the dual goals of the economy.
Gradual rate cuts Musallam indicated that it is appropriate to continue reducing the target range for the interest rate. size and timing of the cuts should depend on incoming data. Evolving expectations also play an important role in the decision-making process.
Growth Outlook Musallam expects the US economy to continue to grow at a solid pace. The labor market is expected to remain healthy, close to full employment. Inflation is expected to approach 2%.
Lecture Details In the lecture, Musallam discussed current financial conditions across the economy. He also spoke about their implications for future expectations. He added that he will present alternative scenarios and their policy implications.
Personal Opinions Musallam emphasized that the views he presented represent his personal views. They do not necessarily reflect those of his colleagues on the FOMC. In this speech, Musallam explained the importance of monitoring financial conditions and economic expectations. Current trends indicate cautious optimism about economic growth.
Financial Conditions and Their Impact on Monetary Policy
Financial conditions play a vital role in the transmission of monetary policy to the broader economy. Therefore, in my preparation for FOMC meetings, I focus on understanding the availability and prices of funding. Here is my view of current financial conditions.
General Financial Conditions General financial conditions in the United States show broad support for continued economic growth. Funding is generally available, but conditions vary across the economy.
Indicators of Financial Conditions Leading indicators show that financial conditions were relatively tight in 2022 and early 2023. However, these conditions began to ease following the banking turmoil in the spring of 2023. Conditions have become more accommodative than average over the past four quarters.
Lower Inflation and Interest Rate Expectations Lower inflation in the second half of 2023 has contributed to the easing in financial conditions. Changes in the Fed’s interest rate outlook have also contributed to this improvement.
Yield Performance in 2024 Yields on corporate and Treasury debt have risen slightly in the first five months of 2024. This rise comes after inflation stalled, weighing on the Fed’s interest rate outlook. However.
Yield Changes Yields have declined since then due to lower inflation and a slowing labor market. This suggests that financial conditions remain favorable. Analysis of the Financial Condition When analyzing the broad measures, financial conditions appear favorable for companies, municipalities, and households with access to capital markets. However, conditions are less favorable for some smaller companies and households.
Lending and Debt Environment Low credit spreads and strong demand continue to provide a favorable environment for large corporate bonds and debt-backed loans. Equity Issuance New equity issuances and initial public offerings remain below pre-pandemic levels. However, such issuances have increased over the past two years, as companies have taken advantage of lower equity financing costs to raise money.
Credit Quality and Financial Stress
Credit quality and financial stress metrics have deteriorated slightly in recent months. However, these metrics remain low, especially among prime borrowers. Outside of commercial real estate, most debt, such as corporate debt and mortgages, is in strong credit quality.
Bond Market Performance Corporate bond and leveraged loan default rates are nearing their pre-pandemic lows. Small business loan default rates also remain low.
Loan Modifications Loan modifications continue to rise for both banks and private credit issuers. These modifications help stressed borrowers avoid default, helping to maintain production and employment.
Default Rates In contrast, auto loan and credit card default rates have been rising for several months. These rates are now above their pre-pandemic levels. This increase suggests that some households, especially those with low and moderate incomes, are facing greater financial stress. Monitoring Financial Stress These financial stresses are worth monitoring, and I will discuss them in more detail later. The impact of funding costs Low funding costs for borrowers with access to capital markets point to the current state of the economy..
Economic Sensitivity The economy may be unusually sensitive to asset prices in this environment. This state suggests that the relationship between monetary policy, financial conditions, and asset prices may be tighter than usual.
Assessing Economic Conditions Accordingly, I will provide my assessment of current economic conditions and the outlook. This assessment will help understand the impact of these factors on the broader economy.
As with interest rates on loans to small businesses, rates charged to household borrowers remain higher than they were before the pandemic but have begun to ease. Credit card and auto loan rates have held steady, but mortgage rates have fallen from their peaks, with the average rate on 30-year fixed-rate loans falling by more than 100 basis points
Economic Conditions and the Fundamental Outlook
The US economy continues to expand at a steady pace, with the Federal Reserve closing in on its dual goals. But what are the possible scenarios for this expansion? Let’s start by reviewing the recent data that supports my forecast.
Economic Activity My baseline forecast is for continued economic expansion over the coming quarters. This expansion is predicated on a gradual easing of monetary policy and accommodative financial conditions. The first half of 2024 saw strong growth in GDP and labor productivity. Tracking projections suggest that third-quarter GDP growth was also strong.
GDP Level Estimates of potential GDP remain uncertain. However, the level and growth of third-quarter GDP appear to have been slightly above long-term potential. Recent data revisions have not significantly affected these facts, but have increased my confidence in them.
Labor Market and Consumption A full-employment labor market, coupled with the wealth accumulated from gains in stocks and home values, provide strong reasons to expect consumer growth in the coming quarters. Core retail sales in August beat market expectations, but growth in overall consumer spending was weak.
Challenges for Low-Income Households Many households, especially those with low incomes, are experiencing financial stress due to high inflation and interest rates. This situation requires spending trade-offs. However, low-income households have maintained consumption growth similar to high-income households by switching to cheaper brands and shifting to essential products.
Financial Stress Rising auto loan and credit card delinquency rates suggest that some households are facing financial stress. This could strain their ability to sustain consumption growth. Consequently, some slowdown in overall consumption growth could be expected in the coming quarters, especially if the labor market weakens.
