The Fed may be compelled to slash interest rates in half next year to stave off a looming recession, according to a recent report by Swiss multinational investment bank UBS.

In its 2024-2026 outlook report published on Nov. 20, UBS said the U.S. economy is in for a shocker next year as consumers are running through the last shreds of post-pandemic savings.

“According to our estimates, spending in the economy looks elevated relative to income, pushed up by fiscal stimulus and maintained at that level by excess savings,” the bank noted in its report.

Those “excess savings” refer to the extra cash Americans stowed away during Covid when government lockdowns prevented them from spending their stimulus checks. According to Fed researchers, excess savings were likely depleted in the third quarter of 2023, falling from a peak of $2.1 trillion to around $190 billion.

Without that cushion, consumers will struggle to maintain their brisk spending pace, especially as income growth weakens and unemployment rises. According to James Knightley, chief international economist at ING, the current mismatch between spending and earnings “is not sustainable.”

UBS’ most eye-popping prediction is that the Fed could slash interest rates up to 275 basis points to prevent a major recession. That would bring the federal funds rate down from the current rate of 5.5% to 2.75%.

How a rate cut would impact consumers

The federal funds rate directly and indirectly influences the interest rates consumers pay for buying homes, paying off debt, and opening new lines of credit. If the Fed lowers the rate, interest on most of these types of loans will follow suit.

The most immediate impact could be felt in the housing market, where sales have crashed to 13-year lows as mortgage rates reached their highest levels in over two decades.

“When interest rates come down, everyone’s going to come back to the marketplace,” said Melissa Cohn, regional vice president of Williams Raveis Mortgage, referring to the housing market.

Lower rates could also help Americans save on the $1.08 trillion in credit card debt they owe. Fed data shows that average credit card rates have eclipsed 21% and are even as high as 30% for retail credit cards.

Independent research shows nearly one in four Americans goes deeper into debt each month just to afford basic expenses, while one in ten is in “persistent debt,” meaning more of their money goes toward interest and fees than paying the principal balance.

Reading the Fed’s playbook

The Fed has remained tight-lipped about the trajectory of interest rates because its fight against inflation isn’t over. But as CreditNews reported last week, analysts are becoming more convinced that inflation is heading in the right direction and that further rate hikes are off the table.

That’s because the consumer price index was flat in October on a 12-month basis, while “core” inflation, which includes food and energy prices, fell to its lowest level in two years.

“The sources of inflation are disappearing quickly,” Wilmington Trust’s chief economist, Luke Tilley, said at the time.

With rate-hike odds disappearing, traders have placed meaningful bets that the first rate cut could occur in March. According to CME Group’s FedWatch Tool, there’s a 29% probability of that happening.