One year ago, most forecasts were less optimistic about the opportunity for continued economic expansion through 2024. Additionally, aggressive policy action was anticipated by the Federal Reserve to navigate a soft landing as fears of a recession loomed. The economy continued to grow at a much better rate throughout 2024 than expected, as demonstrated in the chart below. The resiliency of the US economy continued to be supported by solid wage growth and consumer spending. Furthermore, the Fed took longer to begin easing monetary policy than many expected; delaying the first interest rate cut until September.
Looking ahead into 2025, we expect continued solid growth for the US economy, albeit at a slower pace than the strong 3.0% and 3.1% achieved over the second and third quarters of 2024. A softening labor market, along with sticky inflation, represent the primary concerns expected to slow the growth of the economy. Contrarily, the generally business-friendly Trump administration policies should provide tailwinds for economic growth, continuing to be supportive of a strong dollar, which has steadily improved since just before the election. On balance, we expect a slight, but not meaningful, decrease in economic productivity.
Banks, credit unions, and financial institutions can see the light at the end of the tunnel as the margin squeeze from the Federal Reserve’s 550 basis point hike in interest rates has reversed course. Since September, the FOMC has enacted 3 rate cuts totaling 100 basis points; thereby dropping the upper bound of its target range from 5.50% to 4.50%. Stickier inflation, however, remains a meaningful concern, limiting the extent to which longer-term interest rates can decrease. On December 18th, the FOMC enacted its final 25 basis point cut in 2024 and aggressively adjusted its previous rate cut forecast for 2025 via the SEP (Dot Plot) from 4 cuts totaling an additional 100 basis point decrease to only 2 cuts totaling a further 50 basis point decline. Officials expressed concern that Fed policy must remain more restrictive to combat stickier inflation as the previous disinflationary environment has stabilized. Arguably, the market got ahead of itself throughout the summer, pushing interest rates significantly lower (10-Year Treasuries touched 3.61%). Since then, rates have risen nearly 100 basis points as the market’s over-exuberance was put in check.
More important than the absolute level of rates, however, is the shape of the yield curve. As demonstrated below, the spread between 3-Month Treasury bills and 10-Year Treasury notes has finally ended its 2-year period of inversion. This constructive development should continue throughout 2025, allowing funding costs to decline and lending margins to improve. Though rates will likely remain elevated in a “higher-for-longer” environment, the beginning of an upward-sloping yield curve is constructive for lending institutions and financial services businesses.
Historically, the eventual disinversion of an inverted yield curve has preceded every recession since the 1950’s. It is important to note that a “false start” occurred only once, when the yield curve sustained an inverted shape but a recession failed to materialize after normalizing. In essence, there is a correlation between an inverted yield curve and a subsequent recession, but correlation does not equal causation. Given the strength of the economy, expected continued growth prospects and to-date positive results from the Fed in navigating a soft-landing scenario, we do not expect a recession to follow at this time.
It will take many months before the business-friendly policies of the Trump administration provide a boost to the bottom line and drive profitability. Expectations for a less intrusive regulatory environment, however, may be somewhat offset by the need to continue to invest in technology and cybersecurity. On balance, the pendulum has swung in favor of banks, credit unions, and other financial services businesses. It is unlikely that the rebound will be an aggressive move up and to the right, but every journey starts with the first step and, at this point, we can clearly see that opportunity is on the horizon.
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