You don’t have to be an economist to run the Federal Reserve. But a pilot’s license might come in handy.
After all, aeronautical terms are regularly thrown around by investors, economists and even policy makers as they discuss whether the Fed can bring down inflation without dropping the U.S. economy into a recession.
The debate is whether the economy will suffer a recessionary “hard landing,” slamming into the ground and causing substantial damage, or a “soft landing,” in which the economy gently comes back to earth and taxis to the terminal. Those well-worn terms have been used for decades to describe Fed-induced economic downturns.
Now, more economists and strategists are talking of a potential “no landing” scenario, in which the economy skirts recession altogether. Think of a pilot aborting a landing at the last second, pushing up the throttle and climbing back into the sky. It sounds good, but there’s a catch.
Here are the arguments for each scenario:
A run of hotter-than-expected U.S. economic data over the last couple of weeks has blunted fears of a 2023 recession, but they haven’t been banished. A reminder came Friday in the form of the Conference Board’s Leading Economic Index, which fell again in January.
“Reasonable minds can disagree about whether the economy is headed for recession or a soft landing, especially after a recent run of strong data. The Leading Index is not waffling however,” said Tim Quinlan and Shannon Seery, economists at Wells Fargo, in a Friday note, with its 10th straight decline “still consistent with recession.”
The LEI is a gauge of 10 indicators designed to show whether the economy is getting better or worse. The index fell 0.3% in January after a 0.8% fall in December. Economist David Rosenberg, founder of Rosenberg Research & Associates, calls the LEI “a 100% ironclad recession forecaster.”
Measures of manufacturing activity indicate contraction, while the yield on the 10-year Treasury note trades far below the yield on the 2-year note Such inversions of that portion of the curve have reliably preceded recessions, with a lag, for decades. That said, some economists, including the researcher who discovered the relationship between the curve and recessions, have doubts about its signaling power in the current environment.
A continued run of resilient data in other areas, particularly the all-important jobs market, lifted hopes that the economy can withstand the Fed’s aggressive campaign of rate hikes that began nearly a year ago and appears unlikely to have run its course until this spring or summer. The January jobs report was widely described as a blowout, with the economy adding 517,000 jobs and the unemployment rate falling to 3.4%, its lowest since 1969.
That also leaves investors and economists focused on weekly jobless claims and other labor data for any sign of a shift.
“It is tough to have a recession with the unemployment rate at its lowest in a half-century. If the economy is to avoid recession, employment will be the key,” wrote Quinlan and Seery.
January retail sales also proved much stronger than expected, rising 3%, underlining the strength of the consumer and showing the economy continues to grow.
Skeptics doubt that the economy can avoid recession given how aggressively the Fed has attempted to slow the economy, taking the fed-funds rate from near zero to a range of 4.5% to 4.75% in less than a year. The full effect of those interest rate increases are likely yet to work their way through the economy, and more are on the way.
“Hopes for a soft landing have grown, but the cumulative effects of the Fed’s rate hikes are likely to eventually stall growth,” wrote strategists at Glenmede.
In a no landing scenario, the economy averts recession altogether. A still-hot labor market and a healthy consumer are seen providing the fuel that allows the economy to grow and potentially accelerate. And while activity in the manufacturing sector may be contracting, the services sector, which accounts for around 80% of the economy, is still going strong.
Growing interest in the no landing scenario has divided traders “over what matters more to the stock market — rising rates or a resilient economy,” said Matthew Weller, global head of research at Forex.com and City Index, in a note.
Optimism over a resilient economy may explain the continued outperformance of technology and other growth stocks in the face of a continued rise in Treasury yields, “as traders weighed still-high prices against recent economic and earnings data that give scant sign of a serious slowdown,” he wrote.
The potential catch is that economic resilience will make for sticky inflation. Investors have largely come round to the Fed’s view that interest rates will need to rise higher than markets had anticipated just a few weeks ago. But now, the Fed may move its own expectations even higher after the January consumer-price index and the producer-price index offered signs inflation is now retreating at a slower pace.
Indeed, stocks stumbled the past week, with the S&P 500 suffering a second straight weekly decline and the Dow Jones Industrial Average falling, while the Nasdaq Composite hung on to a gain. A pair of regional Fed presidents on Thursday said they would have backed a half-point rate rise at the central bank’s Jan. 31-Feb. 1 meeting, which saw policy makers deliver a quarter-point hike.
“The bottom line is that higher interest rates for longer is negative for consumer spending, capex spending, and corporate earnings,” said Torsten Slok, chief economist and partner at Apollo Global Management, in a Friday note.
A “no landing” scenario is bad news for stocks, particularly rate-sensitive tech and growth names, and in the end only delays a hard landing, Slok has argued.