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Business News/ Economy / US economy shows resilience, but is soft landing a strong possibility?

US economy shows resilience, but is soft landing a strong possibility?

The US economy shows resilience and hopes for a soft landing, but risks remain.

The US economy has been able to avoid a recession this year. AFP. (Photo by BILL PUGLIANO / AFP) (AFP)Premium
The US economy has been able to avoid a recession this year. AFP. (Photo by BILL PUGLIANO / AFP) (AFP)

Despite undergoing one of the most aggressive monetary tightening phases in recent history, the US economy is displaying remarkable resilience, raising hopes that the world's largest economy might achieve a 'soft landing.'

However, US Federal Reserve Chair Jerome Powell appears cautious as he acknowledges that such an outcome is merely a possibility which will depend on numerous factors beyond the control of the US Fed.

Powell indicated that a "soft landing" for the economy is not the most likely or expected outcome, but it is still considered a possibility.

"I've always thought that the soft landing was a plausible outcome... ultimately, this may be decided by factors that are outside our control at the end of the day, but I do think it's possible," Reuters quoted Powell saying during a press conference last week.

"The autoworker strike, a possible government shutdown, the resumption of student loan repayments, higher energy prices, and higher long-term borrowing costs are among risks that Powell noted could affect the trajectory of the economy, inflation and, ultimately, where Fed policymakers decide they need to take rates," the Reuters report said.

The US Fed maintained a pause on interest rate hikes in its latest policy meeting but indicated at least one more hike by the end of the year was on the cards.

The US economy has been able to avoid a recession this year and a majority of experts still believe that the economy will achieve a soft landing but some of the experts warn this expectation could be misleading.

For example, Pacific Investment Management Company LLC (PIMCO) believes that the market may be ignoring the risk of at least one more rate hike from the US Fed before the year-end and a looming US recession.

"Markets may be underestimating the risks of both a US recession and one more interest-rate hike from the Federal Reserve, making haven assets a preferred play," Bloomberg reported, quoting PIMCO saying so.

The soft landing scenario

When the Fed started raising rates aggressively to bring inflation under control, concerns started mounting that it would deal a severe blow to the economy, causing a recession. However, concerns over a looming recession started easing gradually as macroeconomic data showed the economy was not slowing significantly. This gave birth to the belief that the US economy was set for a soft landing.

The soft landing of the economy generally refers to a gradual, relatively painless slowdown in the economy. A central bank aims for a soft landing when it seeks to control high inflation by raising interest rates just enough to stop an economy from overheating. In simple terms, it wants to raise rates but without causing a severe economic downturn.

According to a Reuters report, "Fed officials expect economic growth to slow next year to about 1.5 per cent, from 2.1 per cent this year, and for the unemployment rate to go no higher than 4.1 per cent, the latest quarterly summary of their projections shows. That's just a smidge higher than the 4 per cent level they see as sustainable in the long run, and only a few tenths more than its current 3.8 per cent level."

Sujan Hajra, Chief Economist and Executive Director at Anand Rathi Shares & Stock Brokers said although the Federal Reserve would ideally aim for a soft landing, there is no guarantee that this desired outcome will materialise.

He pointed out that there exist extensive domains within the realm of policies, such as fiscal policy or foreign trade policy, that lie beyond the jurisdiction of the Federal Reserve. Likewise, the conduct of entrepreneurs or consumers proves challenging to anticipate amidst times of economic uncertainty. The presence of these various elements further complicates the Federal Reserve's ability to accurately forecast the future trajectory of the economy.

"There are discernible indicators of a deceleration in the United States economy, leading us to consider the potential occurrence of a technical recession, characterised by two consecutive quarters of negative economic growth, as a plausible outcome," Hajra said.

"Simultaneously, it is noteworthy that the fiscal policy in the United States continues to exhibit a high degree of accommodation, which is expected to effectively prevent a protracted decline in GDP. In line with the projections made by the International Monetary Fund, we anticipate that the United States will see a significant deceleration in economic growth in the year 2024, although it is not expected to result in a recession," Hajra said.

G. Chokkalingam, Founder and Head of Research at Equinomics Research pointed out that despite rates going up by 500 bps over the last two years, the US economy avoided any significant deflationary conditions and employment levels remained robust. Now with a significant slowdown in economic growth in Europe and China, the world economy including the US economy, is unlikely to see any further spurt in inflation levels.

"We believe the US will see a soft landing. However, the US markets may remain volatile with a downward bias in the short term due to rising fiscal deficit and debt, and possible delay in finding an amicable solution to the US debt ceiling issue in the short term," Chokkalingam said.

But the challenges persist

The markets and the US Fed may think that the US economy was heading to a soft landing but history shows it is a rare outcome.

As a Wall Street Journal report highlighted, many economists had expected the US to achieve a soft landing ahead of recessions in 1990, 2001 and 2007. That did not happen. This time too, optimism about a soft landing is high.

Another question is whether the soft landing will last longer. If the US Fed keep rates high for a longer period, it is bound to cause an economic downturn. Even though the US achieves a soft landing, the Fed will have to cut rates quickly rates and keep them near the "neutral rate" which neither slows nor boosts economic growth.

But this won't be easy, thanks to sticky inflation.

"Since World War II, economists say, the US has achieved only one durable soft landing, in 1995. The 1995 soft landing occurred after Fed officials pivoted quickly to cutting rates. Back then, inflation was around 2 per cent and Fed officials were lifting rates to prevent it from rising. Today, with inflation above 3 per cent, they are trying to force it down," a Wall Street Journal report observed.

Some experts go to the extent to say that the risk of a US recession is looming.

"The risk of a recession in the US remains elevated. The main factors still driving the US economic growth are strong consumer spending and low unemployment," said Nitin Agrawal, CEO of Torus Oro PMS.

Agrawal underscored that the geopolitical situation is expected to be volatile and crude oil prices are likely to rise further. The US has already drawn their strategic reserves low and high oil prices may see the resurgence of inflation. Moreover, the US fiscal deficit spending is also quite high.

"The Fed has made it clear that they will focus on bringing down the inflation and the interest rates will remain high for a long period of time. If inflation rises, the odds of recession will increase as the Fed will have to raise rates further. In any case, the real growth is expected to be on the lower side," said Agrawal.

Amit Goel, Co-Founder and Chief global strategist at Pace360 said while the US Fed is non-committal on the prospects for a soft landing, history suggests that a hard landing is almost a certainty. At the peak of an interest rate cycle, by definition, the economy is strong and a soft landing looks likely if not a certainty.

Goel added that the higher rates take a couple of years to work through the economy and almost invariably result in a recession.

"We expect a slowdown to start as early as Q4 of 2023 and a recession to be firmly in place by the first half of 2024. If we look at the US micro-cap index it is already in the negative on a YTD (year-to-date) basis and has been a far better barometer of an approaching slowdown than the large-cap indices. We expect large drawdowns in US and Indian equities over the next six to seven months as the markets discount an inevitable recession," said Goel.

Disclaimer: The views and recommendations above are those of individual analysts, experts and broking companies, not of Mint. We advise investors to check with certified experts before making any investment decisions.

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Published: 25 Sep 2023, 02:53 PM IST
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