7 factors driving equipment finance in the year ahead.
THE U.S. ECONOMY has been full of surprises over the last 12 months. First and foremost, we managed to avoid a recession in 2023 due to the strength of the American consumer and labor market. Despite high interest rates, almost 2.7 million new jobs were created last year, most of which were in healthcare, accommodation and food services, and state and local government. Meanwhile, inflation, which peaked near 9% in mid-2022 and was 6.4% a year ago, is now hovering around 3% — within sight of the Federal Reserve’s 2% target.
Despite these positives, the equipment finance industry had an up-and-down year. Equipment and software investment was volatile, with strong growth in Q2 sandwiched between two quarters of relative stagnancy. While some manufacturers benefitted from federal funding provided through the Inflation Reduction Act, Infrastructure Investment and Jobs Act, and CHIPS Act, overall industrial activity was weak, leading to reduced demand in several equipment verticals. As a result, real equipment and software investment grew at just 3% in 2023. Further, with interest rates at multi-decade highs, new business volume growth was essentially flat according to ELFA — and actually contracted in inflation-adjusted terms.
This year, we expect that many of the trends that defined 2023 will continue. For example, we believe the overall economy is likely to continue to slow but remain above water, equipment and software investment growth will remain modest, and inflation will continue to ease. At the same time, we will be closely watching a handful of emerging trends that will loom large over the economy and industry this year.
Here are seven predictions and expected trends that we believe will shape the economy and industry in 2024.
1. The economy appears likely to achieve a soft landing.
Although not yet a fait accompli, the U.S. economy is on track to achieve a soft landing in 2024. Inflation has returned to more acceptable levels without the widespread job loss that is often paired with a rapid increase in interest rates, and consumer sentiment is improving. A year ago, we wouldn’t have bet on the Fed’s ability to thread the needle this well, especially after falling behind the curve in 2022. Jay Powell deserves credit for his job performance over the last 18 months, as he has successfully led the Fed’s efforts to pump the brakes on the economy while keeping the train on the tracks.
That said, it is still premature to declare victory, and there are reasons to worry that the “last mile” could be more difficult than some may expect. For example, while much of the deflation that occurred last year was triggered by lower energy prices (a trend unlikely to be repeated) and the normalization of supply chains, other components of inflation have shown less progress, including “core services excluding shelter” (think electricity, haircuts, or pet care) which have risen at a 4.4% annualized rate over the last six months. When inflation works its way into core services, it can be difficult to unwind.
Moreover, bringing inflation to heel is only one component of a successful soft landing: the economy must also continue to expand at a sustainable level (i.e., 1.5% – 2.5%), and while we achieved this level of growth last year, abnormally high government expenditures played an important and underappreciated role in that performance (and are unlikely to do so again this year). Meanwhile, consumer spending may weaken as financial stress rises, and global economic conditions remain weak.
Overall, we think a soft landing is the most likely outcome, as we wrote in the Foundation’s 2024 Economic Outlook published in December. Still, a recession is still possible, particularly during the first half of the year.
2. Equipment and software investment may disappoint in 2024, but should strengthen as the year progresses.
In 2023, equipment and software investment activity was underwhelming. While Q4 numbers are not yet available, real investment growth likely clocked in at around 3.0%, which would represent the third-weakest year for industry investment since 2010 (only 2016 and pandemic-distorted 2020 were worse).
Unfortunately, we do not expect conditions to change materially this year. Our official forecast calls for 2.2% real growth in equipment and software investment, with growth concentrated during the second half of the year. Per the December edition of the Foundation-Keybridge Equipment & Software Investment Momentum Monitor (a leading indicator for vertical-specific investment activity), eight of the 12 tracked verticals have momentum readings that are below their historical average, signaling a relatively weak near-term investment environment. High interest rates are undoubtedly weighing on capital expenditure plans, and the combination of an uptick in geopolitical volatility and rising financial stress among both businesses and consumers may lead some companies to delay investments they might otherwise make.
Still, our Momentum Monitors indicate that a few equipment verticals should perform reasonably well this year, including Computers, Software, Ships & Boats and Aircraft, while others such as Materials Handling, Medical and Construction are showing positive movement. Further, the hundreds of billions of federal dollars authorized by major legislation passed in 2022 should boost demand for several types of equipment (more on this later).
U.S. Equipment and Software Investment Growth
(Y/Y Percent Change)
Source: Equipment Leasing & Finance U.S. Economic Outlook
3. Interest rates will fall in 2024, though probably not as much as markets expect.
While financial markets are currently projecting five to seven rate cuts over the course of the year, we think this is out of step with the Fed’s messaging and expected economic conditions. Interestingly, if the Fed were to cut rates this aggressively, it would suggest substantial concern that a recession is imminent or ongoing—indeed, the last time the Federal Funds Rate fell by more than 100 basis points (bps) over a 12-month period without a recession was the mid-1980s—and as previously discussed, we do not believe a near-term recession is likely.
Instead, we take the Fed at its word that “higher for longer” is the likeliest outcome, and from our standpoint, it is the most appropriate course of action to ensure the embers of inflation don’t reignite. If the economy cools during the first half of the year as we expect, then the Fed is likely to respond with two rate cuts (25 bps each) over the course of its March, May and June meetings. By mid-year, we expect core personal consumption expenditures (PCE) inflation will have stabilized at or around 2.5%, giving the Fed more room to cut rates once more in Q3, for a total of three rate cuts (or 75 bps) for the year. Three rate cuts is consistent with a soft landing scenario in which economic activity slows but remains positive and investment accelerates over the course of the year.
4. Manufacturing will face headwinds, but some sectors will thrive.
A bifurcated manufacturing industry faces a mixed outlook for 2024. Elevated interest rates will continue to hamper manufacturing in several sectors, as higher borrowing costs reduce demand for automobiles and other products. To be sure, manufacturers may benefit from falling interest rates in the second half of 2024 and we expect industrial activity to pick up during the latter half of the year, but relief depends heavily on easing inflation (i.e., it is not guaranteed). Moreover, weaker global growth will also reduce demand for manufacturing exports, and labor shortages and high labor costs will remain a challenge.
Despite these headwinds, recent legislation will continue to direct billions of dollars in federal spending and incentivize private investment for infrastructure, semiconductors and green technology. Indeed, manufacturing for construction and extractive industry machinery, batteries & electrical equipment, and power transmission equipment boomed in 2023 and should continue to thrive next year. As a result, the prospects for the manufacturing industry in 2024 vary widely by sector.
5. Financial stress will be a key economic factor to watch in 2024.
While consumer activity has produced stronger-than-expected economic growth over the last two years, Americans have relied more heavily on credit cards, “buy now pay later” offers and other forms of credit. As we wrote in the Foundation’s 2024 Economic Outlook, the average annual growth rate for revolving credit over the last two years is roughly four times higher than during the eight years preceding the pandemic. While faster growth is partially the result of the substantial deleveraging that occurred in 2020–21, the current growth rate is still far above pre-pandemic levels and likely not sustainable. Meanwhile, higher interest rates mean that repaying this debt is significantly more expensive.
Given the rapid increase in both consumer debt levels and the cost of servicing that debt, it is not surprising that U.S. consumers are exhibiting increasing signs of financial stress. For example, the share of households reporting difficulty paying their usual expenses rose steadily in 2023 and reached a post-pandemic high in October, while the share of credit cardholders who are newly delinquent is now above 2019 levels across income quartiles.
Businesses are also experiencing higher financial stress. ELFA reported in December that industry charge-offs are up 10 bps over the last 12 months (although they are still at a relatively benign 0.40%), while 30+ day receivables rose to 2.5% in November—the highest reading in a non-pandemic month in more than a decade—before falling back to 2.0% in December. Among smaller firms, Equifax recently reported that financial stress has been building on Main Street for months, and as of October, most industries were experiencing delinquency and default rates well above their long-term average. The increase in financial stress is particularly apparent in the transportation sector, where delinquency and default rates have climbed 171 bps and 444 bps, respectively, over the last year. High borrowing costs and labor cost pressures are likely to continue to pinch employers this year, particularly if the economy slows and demand eases.
6. Increased consolidation in the banking industry may create opportunities for independents.
M&A activity in the banking sector was muted in 2023 but is poised for a turnaround this year. The number of bank deals declined by roughly one-third last year compared to 2022, but we expect M&A activity could accelerate this year as banks scale up in part to manage increased regulatory costs more efficiently. New capital rules related to Basel III and regulatory requirements related to Section 1071, CRA revisions and a variety of new restrictions and requirements for debit and credit card issuers will put additional cost pressure on small and mid-size banks, and the cumulative effect of these rules, combined with slower economic growth, could lead to more consolidation.
Though increased regulatory requirements will affect most industry participants, banks are likely to feel the effects more acutely, which could lead to new opportunities for independents (particularly larger independents) who have sufficient access to capital and are willing to be flexible and offer customized products, particularly in the small-ticket and mid-ticket segments.
7. Leveraging AI and other emerging technologies will play an increasingly important role in the industry.
Two years ago, the Equipment Leasing & Finance Foundation’s Industry Future Council (IFC) issued a report that covered, among other topics, the technology-related trends that would have the greatest impact on the industry over the subsequent five years. The report focused on how emerging technologies could impact sales and operations, as well as open the door to new workforce challenges and cybersecurity threats. Among the technologies discussed in the report was artificial intelligence, which has risen exponentially in prominence over the last two years due to remarkable breakthroughs in AI language learning models such as ChatGPT.
The game changing potential of AI is clear, but the industry is still in the early stages of leveraging these tools to enhance efficiency and profitability. As the IFC reported, a willingness to invest in and experiment with new tools to improve sales and business operations is likely to be a key differentiator for equipment finance firms. Indeed, AI is increasingly being used in the financial services industry to assist with lending decisions and fraud detection, reduce operating costs, increase productivity and enhance security. Moreover, while the report found that building AI capabilities requires specialized skills and substantial investment that may be out of reach for smaller firms, the rapid advances in open-source AI technology over the last two years has democratized access to AI. The IFC will revisit emerging technological trends, including AI, in this year’s report to help shed light on how industry firms can improve business processes and generate efficiencies and productivity gains.
Download your copy of the Equipment Leasing & Finance Foundation’s 2024 Equipment Leasing & Finance U.S. Economic Outlook Report. Plus, listen to the Foundation’s podcast on the outlook for the U.S. economy in 2024 and specifically how the equipment finance industry may be impacted. Host Kelli Nienaber is joined by Jeff Jensen (Keybridge), Nancy Pistorio (Madison Capital), and Jeff Elliott (Huntington Asset Finance). The group explores potential opportunities and challenges, shares expert insights, and makes some predictions for the year ahead.
