Soft Landing Euphoria Can Be Elusive

In economics, a soft landing refers to a scenario where the economy transitions from a period of rapid growth to a more sustainable pace without entering into a recession. Achieving a soft landing is a desirable outcome for policymakers and economists as it signifies a balanced economic environment that supports continued expansion without the threat of overheating.

Achieving a soft landing benefits the economy by averting the negative consequences of a sharp economic slowdown or recession, such as rising unemployment, declining consumer confidence, and reduced investment. It also helps to stabilize inflation and prevent excessive price growth.

In order for the FED to land the economy perfectly without causing a recession, it would require rate cut timing when unemployment goes above 4.5% and inflation trending towards 2%. Of the two condition, unemployment is more critical since iflation is a lagging indicator and is already trending down.

We think inflation will prove more difficult to reduce to the 2% level since labor markets and wage growth are still high. This has not factored in potential supply shocks in the next six months. In addition, the FED will be hesitant on cutting rates too quickly since it needs to rebuild its credibility.

Expectations for inflation in achieving a soft landing involve keeping price growth at a modest and predictable level, which helps to sustain the purchasing power of consumers and supports healthy economic activity. This is going to be hard to do for the Federal Reserve due to data and montary transmission lags. Thus, our feeling is that the market is pricing the ‘soft landing scenario’ to perfection and will be dissapointed in the future. To summarize;

1. Higher inflation rates or longer will hinder the possibility of a soft landing by eroding consumer purchasing power and unsettling market expectations. Althought inflation has gone down, we fell that further drops will more difficult to achieve. The FED is targeting 2% but some analyst think we are now in a higher inflation environment and this level may in fact be higher, say 3%.
2. The level of unemployment in the labor market has a direct impact on the prospects of achieving a soft landing and estimate the FED needs to keep rates higher for longer to alleviate the tight labor market. Current low unemployment rates indicate a tight labor market, which can potentially lead to wage pressures and inflation, affecting the economy’s ability to attain a soft landing. Unemployment needs to go up to 4.5% or more to spur action by the FED to cut rates.

What are the challenges faced by the central bank in achieving a soft landing?

The central bank faces challenges in achieving a soft landing, particularly in balancing its efforts to contain inflation, sustain economic growth, and minimize the risk of financial disruptions. Additionally, external factors such as global economic conditions and geopolitical events can influence the central bank’s ability to steer the economy towards a soft landing.  On top of all this, the FED has to have perfect timing to pull off a soft landing. History is not on the side of the FED here.