The warnings from the bear camp are getting louder as the historically worst two months of the year for stocks come to an end and the pullback intensifies.Economic data is considered Either too hot, suggesting interest rates will remain higher for longer, or too cold, raising fears of a recession in the coming months. I think the reality is that the overall data is just right and continues to trend toward a soft landing for the U.S. economy in 2024. While expectations for this outcome were next to zero at the start of the year, a growing consensus among Wall Street economists now sees it as a distinct possibility.
If the Fed succeeds in slowing down, there will be a soft landing Economic growth, mainly by raising interest rates to increase borrowing costs, thereby bringing inflation down to the 2% target. The other side of the equation is that it must avoid suppressing growth rates too much and rising unemployment to the point of causing a recession, defined as two consecutive quarters of negative GDP growth. The reason there is so much skepticism about the possibility of a soft landing is because it doesn’t happen very often. Arguably, the last time this happened was in 1995, when Chairman Greenspan doubled short-term interest rates from 3% to 6% in an effort to slow an overheating economy.
That lowered inflation from nearly 3% to the Fed’s 2% target without a significant rise in unemployment.
Chairman Powell faces an even tougher task given that inflation rose above 9% last summer, forcing the Fed to raise short-term interest rates from near zero to 5.25%. Economic growth has slowed to about 2% over the past year, while the unemployment rate has risen to 3.8% from a multi-decade low of 3.4%. Impressively, inflation has fallen to 3.2% and recently increased to 3.7%, entirely due to the surge in oil prices, which I believe is unsustainable in a slowing growth environment. As wage growth and housing costs continue to slow in the coming months, the core interest rate, the Fed’s main focus, should continue to fall.
Opponents claim that rising oil prices will persist and ripple throughout the economy, forcing the Federal Reserve to raise interest rates further or at least keep rates high for longer to further erode demand. However, this assumes that rising oil prices are correlated with demand, which is not the case. The recent spike was due to supply cuts from Saudi Arabia and Russia, which fueled speculative demand for oil futures contracts. That could change immediately, and likely will, as China’s slowing economy and slowing global growth are unlikely to support oil prices above $90 in the long term. The Fed has no control over this, which is why it focuses on core rates.
What’s more, the Fed is focused on inflation expectations, and last week’s University of Michigan consumer survey provided more good news on that front. Americans expect inflation to average 3.1% next year, down from 3.5% last month and the lowest in two and a half years. The five-year forecast fell to 2.7% from 3%, which is a significant improvement for the Fed.
As the deflationary trend continues, we also continue to see signs of economic resilience. Even as manufacturing shows early signs of recovery, consumer spending growth is returning to pre-pandemic levels. The Empire State manufacturing index came in sharply higher than expected in September, raising expectations for future business conditions to their highest level in more than a year. I think this is a harbinger of things to come for the industry, which will be much needed as consumers start spending less on services this fall.
It’s easy to find holes in the soft landing narrative, as any individual upcoming economic data point can be viewed as too strong or too weak on a stand-alone basis. We have to look at them collectively to see continued deflation coupled with below-trend economic growth, allowing the Federal Reserve to begin easing its restrictive policies next year and return benchmark interest rates to neutral levels.