The Fed will shift to 'full-on accommodation' mode in 2024 with nearly 3 percentage points of rate cuts as economy slows, UBS says

• The Federal Reserve is set to shock markets with aggressive interest rate cuts next year, according to UBS.
• UBS said slow economic growth will drive the Fed to cut rates by 275 basis points by the end of 2024.
• "We expect substantially slower growth in 2024, a rising unemployment rate, and meaningful reductions in the federal funds rate," UBS said.

The Federal Reserve is going to shock investors next year by aggressively cutting interest rates amid a slowing economy, according to UBS' 2024 economic outlook.

The firm said it expects economic growth to slow considerably next year after this year's brisk pace of growth, and that should lead to reduced retail spending, a worsening consumer balance sheet, and a continued rise in the unemployment rate.

"We expect economic growth to slow sharply in the next few quarters, with a mild contraction worth half a percentage point in the middle of the year," UBS said in a Monday note.

Over the course of the whole year, the firm expects GDP to grow just 0.3% in 2024, representing a marked slowdown from the 3% gain over the past four quarters.

Meanwhile, UBS expects the unemployment rate to rise more than a full percentage point from current levels to 5.0% at the end of next year. By March, the Fed will start to slightly tweak rates lower.

"However, as the slowdown in the economy and the extra disinflationary leg begin in earnest, we expect the Fed in the second half of the year to turn to full-on accommodation, with more rate reductions, in line with what it has done historically."

UBS said it expects the Fed to cut rates by 275 basis points, leaving the effective federal funds rate at 2.50%-2.75%. The Fed currently has rates set at 5.25% to 5.50%.

That's well ahead of market expectations, according to data from the CME Fed Watch Tool, which expects just 75 basis points of cuts in 2024 that will send the fed funds rate to 4.50%-4.75%. 

Driving UBS' sharp estimate for a reduction in interest rates is their expectation that disinflation will continue throughout 2024, giving the Fed confidence that inflation has been tamed amid slowing economic growth.

UBS expects the Fed to get serious about cutting interest rates in 2024, and said that a lack of fiscal policy support from Washington, DC, will drive the Fed to move forward with the interest rate cuts.

"The historically wide budget deficit, a coming presidential election, and a fractured political landscape to us implies little room for cyclical fiscal support," UBS explained.