Navigating the Soft Landing

Navigating the Economic Landing: Propelling Towards a Soft Landing or Veering Off Course?

Amid the backdrop of the COVID-19 pandemic and subsequent economic upheaval, the pursuit of a soft landing has become not only a significant policy goal but also a topic of widespread discussion among economists, policymakers, and the public.

A soft landing refers to steering an economy away from inflationary pressures and economic turbulence while avoiding a recession. This economic phenomenon is often regarded as a critical objective for central banks, particularly the U.S. Federal Reserve (“Fed”), given its potential to maintain economic stability and safeguard the well-being of citizens.

While there is ample discussion on the topic of soft landings, there are differing opinions on whether the U.S. will be able to achieve one. It is important to recognize that a soft landing is not merely an academic exercise. Rather, it holds implications for the livelihoods of millions, the stability of financial markets, and the overall health of the U.S. economy.

The Soft Landing Concept

The term "soft landing" in economics refers to a scenario in which a central bank, such as the Fed, successfully manages the economy to curb rising inflationary pressures without pushing it into a recession. It represents an economic equilibrium between fostering economic growth and ensuring price stability. However, actually striking this balance requires a complex strategy that relies on several factors.

Inflation control is at the forefront of a soft-landing strategy. The Fed has prioritized keeping inflation in check, with the primary objective to prevent excessive price increases that could erode the purchasing power of consumers and disrupt overall economic stability. Typically, the Fed has held a 2% inflation target to ensure price stability within the economy.

To achieve a soft landing, the Fed must deploy effective interest rate management. The Fed implements monetary policy by employing various tools, with interest rate adjustments being a primary one. By altering interest rates, the Fed can influence the money supply, control borrowing costs, and manage inflation. For instance, during the onset of the COVID-19 pandemic, the Fed quickly reduced interest rates to a range of 0.00 – 0.25% to support the economy. As the economy and relevant indicators turned, the Fed reversed course and began rapidly hiking rates. However, as the Fed now aims for a soft landing, discussions surrounding the reversal and pause of rate hikes and the potential onset of rate cuts have picked up speed.

The level of unemployment and the perceived control of the central bank significantly impacts consumer and investor confidence - another key factor in achieving a soft landing. When consumers and investors have faith in the central bank's ability to control inflation, it fosters trust in the broader economy. This, in turn, encourages consumer spending and investment, driving economic stability and growth. However, too much confidence can also have the opposite effect of reigniting inflation due to increased consumer spending and risk taking.

Historical Context: Soft Landings and the Fed

Historically, soft landings have been elusive, as economic conditions are subject to various external factors, making precise control challenging. Alan Blinder, a Princeton economist and former Fed vice chair, defines a landing soft if GDP declines by less than 1%, or the NBER doesn’t declare a recession after at least a year of a Fed rate-hike cycle. Blinder examined 11 periods of Fed rate increases from 1965 to 2019 and identified five soft or softish landings over that period.

One notable instance of a soft landing occurred in the U.S. in the mid-1990’s. During this time, the U.S. experienced a soft landing under Fed Chairman Alan Greenspan. Faced with the challenge of curbing inflationary pressures during an economic expansion, the Fed implemented a series of gradual interest rate hikes. These well-calibrated moves, paired with other favorable economic factors at the time, successfully cooled down the economy and brought inflation under control without plunging the nation into a recession. This achievement is often cited as a rare success in central banking history.

The COVID-19 Pandemic and Economic Turmoil:

Now all eyes are on the Fed during its pursuit of a soft landing. However, the likelihood of them achieving a successful soft landing must be viewed in the context of recent economic surprises and challenges. Understanding this historical context is essential to appreciate the significance of current efforts to manage inflation and sustain economic growth.

Leading into the pandemic, the Fed was faced with low inflation and slowing economic growth. They aimed to support expansion while warding off deflation. However, the pandemic unleashed unprecedented economic disruptions. The Fed and the U.S. government swiftly implemented measures, including interest rate cuts and massive stimulus packages, to counter the negative pandemic impact. Despite the stimulus efforts, the U.S. experienced a recession – albeit mild and short-lived.

Inflation Concerns Emerge

Amid this turbulent economy, inflation concerns initially remained muted and Fed Chair Jerome Powell along with other experts expressed expectations that any inflation resulting from the economic stimulus would be transitory. However, as the economic landscape evolved, inflation began to emerge as a prominent issue. Despite these initial predictions, annual inflation surpassed the 2% target rate in June 2021 and continued to climb. By June 2022, it had reached a 40-year high, peaking at 9.1%. This surge in inflation triggered concerns and reshaped economic forecasts.

To combat soaring inflation, the Fed began a series of interest rate hikes. Most economists initially predicted that the Fed’s efforts, including raising the short-term interest rates, would lead to a recession—a pattern observed in post-war economic history. The expectation was that reducing inflation would necessitate significant economic sacrifices, including substantial job losses.

Shifting Economic Predictions

However, the presumed recessionary trajectory of the economy began to shift. Surprisingly, consumers continued to spend despite rising prices. This resilience in consumer spending, coupled with other

economic indicators, challenged the conventional recession predictions. For example, the labor market exhibited remarkable resilience. Unemployment rates remained historically low, defying expectations of a recession-induced job crisis. Further, while still above the Fed's target range, inflation rates started to stabilize, offering hope that the central bank's efforts were gaining traction. Additionally, economic data, including robust Gross Domestic Product (“GDP”) growth, further contributed to the shift in predictions.

This dynamic economic landscape demonstrates just how important key indicators are when measuring the efficacy/results of policy. As a result, it becomes critical to assess the current economic landscape to determine whether the U.S. is on the path to achieving a soft landing or if significant challenges and risks persist.

The Current Economic Landscape Shows Signs of Progress

One of the standout features of the current economic landscape has been surprising GDP growth. Over the last two quarters, the U.S. announced an annualized GDP growth rate of 4.9% and 3.3%, respectively. Though growth decelerated significantly from Q3 to Q4, it still exceeded economist expectations by more than 1%. This growth serves as a buffer against recessionary pressures, offering optimism for a soft landing.

The unemployment rate is another critical barometer of the economy’s health. As of late, the U.S. has reported consistent and historically low unemployment rates. Despite the economic challenges posed by the pandemic, unemployment rates have remained remarkably stable, confounding earlier predictions of widespread job losses. The economy continues to create jobs at a robust pace and labor force participation rates have shown signs of improvement. The labor market's resilience has been a significant factor in shaping economic expectations and reduces the probability of an impending recession, thus improving the likelihood of a soft landing.

Policymakers and market participants alike are closely watching the trajectory of interest rates. As mentioned above, controlling inflation is a central objective in achieving a soft landing. Although inflation rates surged to a 40-year high, recent data continues to show signs of stabilization. Inflation rates have gradually receded, hitting 3.4% in December 2023, but remain above the Fed’s target of 2%. However, these stabilizing inflation rates suggest the Fed’s actions may be working.

The latest readings of key economic indicators have also played a pivotal role in reshaping predictions and expectations regarding the U.S. economy. The resilience of consumer spending in the face of rising prices and the overall strength of the labor market have boosted consumer confidence. Low unemployment rates indicate that many individuals are still employed, contributing to consumer confidence and spending. This optimism has challenged earlier predictions of a consumer-led recession. These unexpected outcomes have caused economists and experts to reevaluate their recession predictions with many of them lowering the likelihood of an impending recession.

However, the path forward remains contingent on a range of factors, including ongoing policy decisions and global economic dynamics.

Will This Landing Be Soft? Opinions Diverge

Given the dynamic economic landscape, it should be no surprise that there are diverging opinions about the prospects of the Fed achieving a soft landing in today's economy. While some express optimism and confidence in the feasibility of this economic feat, others remain vigilant and highlight potential risks.

Optimistic economists and policymakers, including Fed Chair Jerome Powell, point to encouraging indicators such as those outlined above (i.e., decreasing inflation rates, stable employment rates and strong GDP growth). They emphasize the Fed’s commitment to implementing effective monetary policy, including interest rate adjustments, to navigate the path toward economic stability. Additionally, the resilience of consumer spending and investor confidence is viewed as a positive indicator. On the other side, less optimistic observers warn that, despite some clear progress, lingering challenges, such as geopolitical risk and lagging policy results, require proactive measures.

Turbulence Ahead? Challenges and Risks Remain

One of the significant challenges is the lag between implementing policy changes and their impact on the economy. Changes in monetary policy, such as adjustments to interest rates, can take time to influence economic conditions fully. The Fed must carefully monitor the economy to ensure that its measures do not inadvertently lead to unintended consequences. Fiscal policy changes, including government spending and taxation, also have lagged effects. Decisions made by policymakers can take time to translate into tangible economic outcomes.

Another growing concern is the potential for the economy to overheat, driven by excessive demand, which could lead to a second wave of inflationary pressures that disrupt the landing trajectory. Historically, inflation has come in multiple waves. At present, if demand outpaces the economy's supply capacity, it may result in upward pressure on prices. This situation could necessitate more aggressive monetary policy measures to cool down the economy, which may pose challenges in achieving a soft landing. Striking the right balance between raising interest rates to control inflation and maintaining economic growth is a complex task. Overly aggressive interest rate hikes can risk triggering a recession, while inadequate measures can allow inflation to escalate.

Geopolitical risks also represent a persistent threat to the stability of the global economy and can impact the U.S. economy directly or indirectly. At present, one of the most prominent concerns is the ongoing tensions between the United States and other major global players, particularly China and Russia. Trade disputes, cyber threats, and territorial conflicts have the potential to disrupt international economic stability, affecting supply chains and global markets. Global conflicts, such as those threatening supply chain disruption in the Red Sea may also impact the direction of the U.S. economy. Additionally, the geopolitical situation in key oil-producing regions, such as the Middle East, introduces uncertainty about energy prices, which can directly impact inflation rates.

Further, significant slowdown in major economies worldwide can have spillover effects on U.S. exports, impacting growth prospects. Currency exchange rate fluctuations can affect trade competitiveness and impact U.S. businesses, particularly those engaged in international trade. Additionally, turbulence in global financial markets can influence investor sentiment, potentially leading to capital flows that impact domestic financial stability.

Addressing these challenges and risks requires a proactive and adaptable approach. Policymakers must remain vigilant, ready to respond to changing economic conditions and external factors that could impact the journey towards a soft landing. Additionally, effective communication with the public and transparent policy decisions will be essential in maintaining confidence in the economic trajectory.

Conclusion: Looking Towards the Landing Pad

The central question on everyone's mind is whether the U.S. will indeed achieve a soft landing. Below, we have summarized the three potential scenarios for what may occur:

Scenario 1: Successful Soft Landing

In this scenario, the U.S. economy continues its current trajectory towards a soft landing. The Fed implements monetary policies effectively, taming inflation without triggering a recession. Economic growth remains sustainable, and key indicators, including unemployment and inflation, stabilize and remain within desired ranges.

Scenario 2: Re-acceleration and Inflation Risks

An alternate scenario involves a re-acceleration of economic growth, driven by strong demand that outpaces the economy's capacity. This could lead to renewed inflationary pressures, requiring the Fed to consider further interest rate hikes to prevent overheating. As part of this, inflation remains a key concern. While it has shown signs of moderating, the risk of unexpected inflationary spikes persists.

Scenario 3: Recession Anyway

The spark that causes a recession is rarely predictable. Some unexpected event or policy error (e.g., keeping interest rates high for too long) can lead to economic deterioration quickly if the underlying conditions are already in place. Additionally, the long and variable effects of monetary policy are also uncertain. In an economy that is still readjusting to structural changes due to the pandemic, and in the wake of one of the fastest rate hike cycles in history, financial conditions and consumer spending remain vulnerable.

While consensus expectations have shifted to a much rosier scenario 1 outcome, we remain hesitant to simply follow the herd. At present, Strategas – a leading macroeconomic research firm, currently puts the odds of a 2024 soft landing at 40%, a recession at 50%, and leaves a chance of 10% for an upside surprise. Regardless, the outlook for the U.S. economy hinges on policymakers' ability to navigate these potential scenarios effectively.

Although the U.S. economy is making strides towards a soft landing, the journey is far from over. Vigilance, adaptability, and a comprehensive understanding of the economic landscape will be essential to steer the economy through the challenges and uncertainties that lie ahead.