Is The Economy Still In for A Soft Landing?

May 21, 2024

The market seems to think so.

The analogy of a soft landing refers to the Federal Reserve engineering the perfect timing of rate cuts such that inflation is tamed without causing a recession. According to the Wall Street Journal, “futures markets were pricing a 75.3% chance of one or more cuts by the Fed’s September meeting … But the July (Fed) meeting remains an interesting dark-horse candidate at 34.9% odds of a cut. (WSJ)”

Put yourself in Fed Chair Jerome Powell’s shoes for a moment. If Powell cuts rates too late, he will force the economy into a recession. This will hurt the middle and lower class, but the 1% will be fine. If he cuts rates too soon, inflation will stick around a lot longer. The monetary tightening we’ve felt the past two years will have all been for naught. Long term inflation hurts everyone.  If forced to choose between two evils, perhaps a mild recession is more easily corrected (i.e. think “controlled”) in the minds of FOMC board presidents (through monetary easing policies) compared with runaway inflation.

If that line of reasoning is true, then you can expect rates to remain higher for longer. That has been the Fed mantra for some time now.

The rate of inflation is slowly trending down with a 3.4% CPI print in April, U.S. businesses hired fewer workers than forecasted, and unemployment ticked up to 3.9% (Forbes). While these data points imply a rate cut is coming soon, I would not hang my hat on these metrics alone for a summer 2024 rate cut even if the same trend continues.

These data points certainly could all go in the direction that the Fed has sought these past couple of years. But the sentiment among Federal Reserve members may be encapsulated by Chair Powell’s peer on the board, Christopher Waller. He recently remarked, “What’s the rush?” when it came to lowering rates (The AP).

But there is a bigger elephant in the room: the inability of Washington to reign in spending. This point is critical. Government over-spending is not new, so what makes this time unique and noteworthy?

The Federal Government has long been making significant payments to service our national debt, which stands at roughly $34 Trillion today (US Debt Clock). But for many years, since the Financial Crisis of ‘08, interest rates were kept low. As such, our economy has experienced sufficient growth to sustain debt servicing payments. After interest rates rose exponentially starting in 2022, any new debt issued by the U.S. requires the government to pay its debt-holders that much more in interest. At the current pace, this becomes rather unwieldy.

Our nation’s persistent budget deficit, and congress’s unwillingness to reign in spending, can have a devaluing effect on the U.S. dollar. In other words, while the U.S. Central Bank is restricting cashflow in the real economy to tame inflation, our government is freely spending (i.e. stimulating the economy). This effectively cancels out a great deal of what the Federal Reserve is doing. For anyone who is paying attention, this clearly cannot go on and something will have to give.

What are our options then (i.e. what has to give?)? There are three scenarios–

  1. We can reign in government spending. Let’s be real -- this is highly unlikely.
  2. We can increase taxes to increase revenue. If no new legislation is put forth, this is what will happen. The Tax Cuts & Jobs Act (TCJA) passed in 2017 is going to sunset on January 1st, 2026. In a couple of years, many of you can expect your tax bill to go up. What I expect will happen, though, is the popular elements of the TCJA won’t go away completely and Congress will approve a brand new tax bill.
  3. We can grow faster as an economy. As crazy as it sounds, this is the likeliest path forward. Even with higher rates, the stock market and the American consumer have been resilient despite headwinds. With the advent of business efficiencies driven by AI and other technologies, we expect (at least in the U.S.) for the winds to be at our backs as we continue moving forward.

So -- back to our original query -- does a soft landing look likely for the economy? While Fed members continually make the point that monetary policy decisions are dependent on economic data, the extent to which government spending/stimulus influences Fed policy cannot be discounted. In other words, the Fed has to make some tough calls. It wouldn't be surprising to see the Fed wait longer on rate cuts, which means that a mild recession might occur. But, even in a scenario where we see a mild recession, the stock market can still climb higher. This has happened in US history. In fact, on average, once stocks have found their low during a recession, the average one-year forward return is +40% (Yahoo Finance). As we've said before, there is a lot for which to be hopeful and we continue to help you invest in these opportunities.

Photo credit: Andre Taissin

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