Rate futures are factoring in about 250 basis points in Fed cuts by September of 2025. Such steep cuts have historically coincided with (deep) recessions. However, there are many important differences between the current economic cycle, and previous ones, notably the ongoing deleveraging by households. Corporates also took advantage of low interest rates to term out their debt. As a result, net interest payments have continued to slide.
The dotcom and housing market busts were foreshadowed by sharp run-ups in investment, that swiftly reversed when the ‘bubbles’ eventually burst. Today, the picture is not one of over-investment. Residential fixed investment remains historically low as a share of GDP (4.0%) despite record immigration levels. Non-residential fixed investment (as a share of GDP) is far below the dotcom peak, and broadly in-line with the average for non-residential fixed investment through the 2010s.
To be clear, the steep ramp-up in capex spending by the major technology companies could eventually test the limits of the grid. The environmental impact of surging AI demand could also further dent big tech companies that have long touted their environmental credentials. There is a plausible bear case for AI. But for now, demand for AI products from the US remains very strong. Taiwanese exports to the US jumped 78.5% y/y in August, led by a 131% y/y surge in exports of information & communication products.
A significant easing has already taken place. The 2-year Treasury yield has fallen 67 basis points YTD to 3.56%. The 10-year Treasury yield is down 25 basis points YTD to 3.63%. Some of the more rate-sensitive sectors of the economy are already rebounding. The Empire State manufacturing survey for September was vastly improved. The environment for commercial real estate, so often touted as the trigger for the next ‘crisis’, is also brightening. The Green Street Commercial Property Price Index increased 1.6% m/m in August and is up 3.3% this year. The impact of the recent slide in Treasury yields is already boosting economic activity.
