US Economy Poised for a Soft Landing. What Comes Next?

Originally written by Darrell R. Spence for Capital Group
Edited for clarity and brevity by Gleba & Associates
August 29, 2024

A great deal of market commentary over the past several months has focused on the
potential for the U.S. economy to achieve a “soft landing.” What exactly is that?

A soft landing essentially describes an economy that slows enough to allow inflation to
fall, but not so much that it tips into a recession. It is an achievement that many
investors doubted could occur two years ago when the Federal Reserve first launched
its fight against inflation.

Even I thought the window of opportunity was narrow. However, since then, inflation
has come down, job creation has cooled but re

mains positive, and the U.S. economy

has avoided a recession. The inflation battle isn’t over, as it remains above the Fed’s
2% target. However, it is close enough that Fed Chair Jerome Powell all but promised a
rate cut during his highly anticipated speech in Jackson Hole, Wyoming, last week.

A resilient U.S. economy has decelerated but hasn’t stalled

 

If the Fed does so at its September meeting, it will be the first rate cut since the COVID-induced recession in March 2020, and it will mark the end of the Fed’s historic two-year monetary tightening campaign that began in March 2022.

What comes next?

Although there is no official definition of a soft landing, it is considered for the purposes of this analysis to occur when real GDP growth expands, on average, for three quarters at a pace below the economy’s potential growth rate (currently 2.0% per the Congressional Budget Office’s estimate) with none of those quarters showing an outright contraction. If the U.S.

economy grows at a 1.5% annualized rate in the third quarter of 2024 — the current consensus estimate — it will have met this definition of a soft landing.

This could be an important milestone because, when it has occurred historically, the economy has tended to accelerate in subsequent periods. This pattern could repeat in 2025, especially if the Fed lowers rates.

 

Interest rate outlook: Temper your expectations

Based on activity in the interest rate futures market, investors expect the Fed to cut rates by 50 to 75 basis points by the end of this year, and more than 100 basis points in 2025. I think there is a reasonable probability that we get less than that.

 

After a few rate cuts, if the U.S. economy continues to grow — or even accelerates, per past soft landings — and job growth remains healthy, I am not sure the Fed would want to risk overheating an economy that appears to be in reasonably good shape. That would be especially true if inflation remains stuck in a range above 2%, as Powell suggested was possible in his remarks last week.

Whenever Powell speaks it is like a Rorschach test. People hear what they want to hear and see what they want to see, and I am likely no different. With that caveat, I do not see the Fed cutting rates as aggressively as the market expects. That said, I am on record predicting that the Fed was unlikely to cut rates at all in 2024, so unless there is some very surprising economic data in the next two weeks, my prediction will be off by a few months. However, we will still likely end 2024 with substantially fewer cuts than the market was expecting at the start of the year.

Early next year, if we are looking at a U.S. economy that is expanding above its potential growth rate — boosted by one or two rate cuts — the Fed might declare mission accomplished and leave it at that. Putting monetary policy on cruise control for a while could make sense, given the importance of price stability following the worst inflation spike in 40 years.

Even with fewer cuts than expected, this environment could still be supportive for stocks and bonds. A growing economy should provide a tailwind for equity prices over the long term, while rates could remain at a level that presents bond investors with a real alternative to equities.

Original article: https://www.capitalgroup.com/advisor/insights/articles/us-economy-poised-soft-landing-what-comes-next.html