Weekly Economic Trends and Indicators
In September, the Federal Open Market Committee (FOMC) of the Federal Reserve voted to decrease the target range for the federal funds rate by ½ percentage point to 4.75 to 5%. Recall that our discussion last week revolved around the uncertainty about the size of the cut in the days leading up to the meeting and the fact that many observers were expecting a more conservative ¼ percentage point move. This week, we continue the discussion of the rate cut by specifically thinking about how the pace of rate cuts could affect the outlook both nationally and locally.
As of Friday, the Atlanta Fed GDPNow forecast of third quarter GDP growth stood at 3.1%, which is nearly equal to the latest estimate of second quarter growth, which was 3.0%. The Atlanta Fed specifically cites increases in the expected third quarter growth in real gross private domestic investment and the contribution of net exports to real GDP growth.
One important reason for the change in expectations for net exports is the value of the dollar. Since the end of July when expectations of a larger rate cut started to pick up, the broad dollar index has decreased by about 2.3% with most of that drop coming in the days around the rate cut. With the dollar fluctuating around its highest level in decades for most of the post-pandemic period, this move is hopefully a sign of things to come as interest rates continue to fall going into next year. It will take another 10% decrease to get down to pre-pandemic levels (which were already historically high but would feel like a welcome relief today), and a sustained program of rate cuts could get us there over the course of the next year or two.
While this is good for the overall national economic outlook, it is especially important for the Quad Cities area because of our heavy concentration of manufacturing firms, many of which are exporters. The fact that the rate cuts have started and that the path ahead is clearer removes some uncertainty that could have been holding back spending on new capital. While it may take a quarter or two for new capital to be put in place and become productive, it does help the outlook for 2025.
By the same token, while the export picture has been rather dismal for the last couple of years because of the strong dollar, a sustained dollar decline would inject some life into export manufacturers. As we have noted previously, the Davenport-Moline-Rock Island IA-IL MSA is the 147th largest in population but the 47th largest in terms of the value of exports.
As a result, these factors which have already been singled out by the Atlanta Fed as contributing to the expected increase in GDP growth are especially helpful for the local economy. A faster pace of rate cuts benefits the Quad Cities more than the national average. Thus, while 2023 and 2024 may see the Quad Cities underperform the national average, this could reverse in 2025 provided the Federal Reserve continues to move toward a more neutral policy stance.
The real interest rate, which is the market interest rate minus the rate of inflation, is what really matters for investment decisions. Success at taming inflation has pushed real rates into restrictive territory which has created a significant headwind against manufacturing and exports. It will take a rapid pace of interest rate cuts to move the real rate toward neutral. For the Quad Cities, a neutral rate will feel expansionary. Hence, the sooner we get there (with a faster pace of rate cuts), the better.
Next week: Labor market update
