Investment Strategy Brief:
Soft Landing Checklist

Below is a transcript of this week’s video.

Hi, this is Jason Pride, Chief of Investment Strategy and Research at Glenmede.

After pausing for the second consecutive month, the Federal Reserve has generated investor hope in the its ability to orchestrate a soft-landing, in which the economy does not enter a recession, but instead resumes growth. As shown on the left, some economists have lifted their expectations for growth into 2024 so as to not include a recession, but the division among the ranks of professional forecasters remains, with others pointing to more dour outcomes.

Importantly, soft landings after substantial Fed tightening have historically occurred as a result of a combination of key conditions including contained inflation, easing monetary policy, loosening bank lending standards, and increased government spending. Let’s take a look at each of these conditions in turn to assess their status as well as the implied likelihood of a soft landing.

In terms of inflation, soft landings in the past have occurred when inflation had already declined notably and provided little risk of surprising to the upside. Arguably, inflation may currently be the closest to being met of the 4 previously-mentioned conditions. If looked at on a rolling 3-month basis, inflation is running around 3.0%, quite close to the Fed’s target 2.0% rate. However, the disparity in results among components remains a bit worrisome. Recent inflation readings are largely driven by declines in prices of goods that had been previously clogged up in supply chain bottlenecks and are now flowing freely. Meanwhile, energy prices are rising quickly, and perhaps most important, the gains in costs associated with both housing and various non-housing services have remained troublingly sticky.

Lower inflation would take the pressure off and allow the Fed the opportunity to back off of its monetary tightening. However, the persistent stickiness of inflation and risk of its resurgence means the Fed cannot back down yet. While it may have announced its second pause at consecutive FOMC meetings, pauses are not rate cuts. In fact, the Federal Reserve and its respective committee members appear to be attempting to strengthen their pronouncements about holding rates high for longer. As a result, while not still tightening, monetary policy will likely remain tight until inflation becomes more clearly contained instead of backing off and providing support similar to past soft landings.

Connected with Fed policy, bank lending and associated lending standards often improve during soft landings as the ease of borrowing by consumers and businesses helps each get through the tougher times of the slowdown. Again, however, banking surveys point to a lack of willingness to lend by these channels, suggesting such support is not in place this cycle.

Last one the list, government spending could accelerate to provide a lift to the economy. In fact, we saw this occur to some degree in the initial 3^rd quarter GDP report, where government spending provided an outsized near-1% of annualized growth during the quarter. However, such circumstances are less likely to be repeatable, since the government is already operating with a large budget deficit and rising interest costs are expected to put growing pressure on the governments’ budget. Political will for such spending is already waning, as reflected by recent leadership instability in the House of Representatives.

Glenmede’s leading indicator continues to point to a modest decline in the economy in the next 6 to 12 months. Such projections reflect the trends in its components, from weak business surveys and consumer sentiment to the lagged effect of monetary policy, as well as a lack of the typical soft landing conditions mentioned before that could provide an offset and allow for a more stable outcome.

So to summarize, soft landings have historically resulted from a set of conditions including contained inflation, supportive monetary & fiscal policies and easing lending. Moderating, but still high inflation is pressuring the Fed to pursue a higher-for-longer rate cycle, which is not that conducive to a soft-landing. Bank lending standards remain tight and rising interest costs are pressuring the government budget and political will to provide support. Leading indicators point to a decline within 6 months, while economists see slow growth at best. The risks of ongoing economic difficulties alongside high equity valuations and high rates justify a continued defensive investment position.

Thanks for listening! And please don’t hesitate to reach out with any questions.