Since early 2022, U.S. policymakers, including Federal Reserve Chair Jerome Powell, have embarked on the challenging mission of curbing inflationary pressures through heightened interest rates, all the while avoiding economic contraction. This elusive equilibrium, historically challenging to achieve—almost impossible, actually—, is what economists fondly refer to as a “soft landing.” Believe it or not, recent signs in the economy suggest that this magical soft landing might not be an impossible dream. While it’s never a given, it is worth looking at in a bit more detail now.
Historical Context
Historically, efforts to tame inflation with increased interest rates have sometimes led to unintended consequences. Often, rapid rate hikes inadvertently plunge economies into recessions, boosting unemployment rates and dampening the investment climate. This is because as borrowing becomes expensive, consumers reduce spending and businesses curtail investments. The results: an economic slowdown or even contraction.
Given this background, it’s understandable why the ideal scenario of a soft landing, where price pressures are contained without causing economic downturns, is seen as almost mythical in economic circles.
Signs of the Times
Recent economic data, however, provides a glimmer of hope. A somewhat declining inflation trend coupled with a sustained growth in economic output has sparked optimistic whispers among economists. Here’s why many believe a soft landing might finally be on the horizon:
Parade of Rate Hikes: Under Powell’s stewardship, the Federal Reserve has raised the benchmark interest rate 11 times. As of now, the rate is the highest it has been in 22 years.1 Yet, even with all of these increases, the economy has refused to be jolted abruptly.
Resilient Consumer Spending: Despite the rate hikes, consumer spending—a significant driver of the U.S. economy—has remained robust. The pent-up demand after the pandemic might also be playing a factor. In any case, this resilience tends to indicate that the economy still has underlying strength.
Semi-Predictable Policy Stance: The Federal Reserve has consistently signaled its readiness to adjust its policies based on evolving economic conditions. This ability to adapt has, so far, helped to navigate the extremely unpredictable waters of global economics.
Skepticism and Vigilance
While the indicators are promising, it’s worth noting that economic predictions are inherently fraught with uncertainties. There are always external shocks, geopolitical tensions, and unforeseen events that can derail even the most optimistic forecasts. So, while there’s growing consensus about the possibility of a soft landing, there’s also a shared understanding of the need for continued vigilance with a bit of skeptical optimism added to the mix.
Some Implications
Understanding a potential soft landing’s impact on the broader economy is important, but we should also look at the various implications for individual investors. Here are just three to consider:
Preservation of Capital: A soft landing implies a smooth transition from a growth phase to a more stable or slower-growth phase without triggering a recession. For investors, this means there should be, in theory, a reduced risk of substantial market downturns or crashes. This would allow them to preserve capital. Investors and, of course, their financial advisors, can focus on long-term growth strategies rather than defensive positions.
Re-Evaluation of Asset Allocation: Even though the economy avoids a hard landing, the slowing of growth can mean different sectors and asset classes will outperform others. Financial advisors may advise clients to re-balance portfolios, possibly reducing exposure to riskier assets or sectors that thrive during boom phases and increasing positions in more stable or income-producing assets.
Fixed-Income Opportunities: A soft landing often involves policy measures like controlled rate hikes. This can make certain fixed income assets, such as bonds, more attractive due to higher yields. As interest rates have risen and become more attractive over the past year or so, interest-bearing instruments have become worthy of investors’ attention again.
The Takeaway
Achieving a soft landing for the U.S. economy would indeed be a remarkable accomplishment, especially given the historical challenges associated with it. The signs are undeniably encouraging, and under the current Fed’s leadership, the possibility seems more tangible than ever. However, in the ever-fluid landscape of global economics, only time will tell whether this optimism translates into a realized economic equilibrium. Whatever happens, it’s helpful to keep in mind that keeping a long-term investment approach will almost always work out better in the long run, even if this soft landing never happens—this time.
Sources:
1 https://tradingeconomics.com/united-states/interest-rate
Are We on the Brink of the Elusive Soft Landing? Signs are encouraging and the possibility seems more tangible than ever; Copyright © 2023 FMeX. All rights reserved. Distributed by Financial Media Exchange.
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