Team Soft Landing Is Starting to Pull Ahead
When it comes to the economy, so-called soft landings are as rare as sightings of Halley’s comet. That’s because the Federal Reserve doesn’t have a great track record in raising interest rates to tame inflation without causing a deep and painful recession, otherwise known as a hard landing. But it’s starting to look like the central bank may just pull off the impossible.
It’s a very perplexing time in the field of economics. Activity has contracted, as measured by the official gross domestic product calculations put out by the Commerce Department, but it doesn’t feel like a recession. The economy has added 2.74 million jobs this year through June. This earnings season has shown that many consumer-facing companies such as Starbucks Corp. and Uber Technologies Inc. are enjoying pricing power, and travel companies are experiencing booming demand, with Marriott International Inc. saying hotel occupancy has nearly returned to pre-pandemic levels. If you have taken a flight within the US recently, you have probably noticed that the plane is completely full and the airports are mobbed. Overall, members of the benchmark S&P 500 Index are on track to post record profits for the second quarter.
If this is a recession, it’s a strange one. But recessions come in all shapes and sizes. The one in 1990 and 1991 was primarily confined to the commercial real estate and the banking sectors, though it took until 1995 for the unemployment rate to fall back to where it was before the recession. In GDP terms, the dot-com bust in 2001 could hardly be considered a recession, but it felt extremely painful due to the massive drop in the stock market. Then there was the financial crisis of 2008 and 2009, which was referred to as the Great Recession because of its depth and duration, with unemployment rising to 10%, the housing market collapsing and personal bankruptcies surging. The Covid-19 recession of 2020 saw the economy contract by the most since the Great Depression and the unemployment rate shoot up to near 15%, but then quickly rebound on the back of unprecedented fiscal and monetary stimulus.
Perhaps the reason why there is so much talk these days about whether the economy is in a recession is because of recency bias, with people remembering how damaging the last two were and thinking the next one will be of the same magnitude. There’s been a great deal of debate on social media about the definition of a recession and when it officially starts. The technical definition is that a recession is marked by two straight quarters of declining GDP, which we just had. But the official arbiter, the National Bureau of Economic Research, takes a wider view, looking for what it considers a substantial decline in activity over a sustained period.
The labor market is the biggest source of cognitive dissonance, with the unemployment rate anchored at 3.6%, just a tenth of a percentage point above the half-century low of 3.5% set in 2019. Although job openings have fallen to 10.7 million from the peak 11.9 million in March, they remain double the long-term average going back to 1999. The Institute for Supply Management’s index measuring growth in the services sector unexpectedly strengthened to a three-month high in July on firmer business activity and orders.
Financial markets are starting to buy into the idea of a soft landing. The S&P 500 has risen more than 13% from the low this year on June 16, yields on US Treasuries have eased back from their highs, the new issue corporate bond market is booming, and the dollar’s rally has taken a breather, for the time being. What all this means is that financial conditions are materially easier than they were just a few weeks ago, much to the chagrin of the macro doom crowd. The Fed’s received a lot of criticism by not anticipating the sharp acceleration in inflation, but if the central bank is able tame inflation without too much economic pain, it would certainly go a long way toward restoring its credibility.
If we’ve learned anything the past couple of years, it’s that the old economic playbooks are no help for what is happening now. Nobody has any experience with the aftermath of an economy that stops on a dime, jettisons some 17 million from the workforce over two weeks and contracts 31% only to rebound just as quickly on the back of free-money government programs that injected trillions of dollars directly into the pockets of consumers to go along with ultra-easy monetary policy. As such, anyone who expects the economy to follow the usual boom-bust patterns is going to be disappointed. It’s plausible that the old economic models are irrelevant, and we need to find something entirely new to guide us through what is happening.
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