If the economy avoids a recession, it will be in spite of the Fed, not because of it.
What goes up must come down — in fame, in politics, in power, and, like it or not, in the economy. The question is just what the down part will look like. Will it be a crash or a gentle return to earth?
For months, the looming quandary has been what will get the United States economy — which has seen surprisingly steady employment numbers and a plague of inflation — back to normal. The conventional wisdom is generally that this necessitates a recession: The Federal Reserve will raise interest rates so much that eventually, they’ll push the economy into negative territory and, in turn, get prices back under control. If that sounds pretty bad, it’s because it is — we’re talking millions of people out of jobs here.
There’s another option, which is a “soft landing,” where the economy cools off without tipping into full-blown recession territory. It’s a bit of an elusive scenario, but it’s not off the table.
Multiple signals in the economy lately have the landscape looking soft-ish. The labor market is still adding jobs, but at a slower pace than during much of the post-pandemic recovery. Job openings are pulling back, wage growth is decelerating, and hiring is slowing down. Inflation appears to be easing as well.
“The real question is are we going to continue to see a soft landing, or are we just seeing the beginning stages of a recession?” said Michael Strain, director of economic policy studies at the American Enterprise Institute, a center-right think tank. “My view is that we are seeing the beginning stages of a recession, but that’s a forecast.”
The risks are real. The Fed is laser-focused on getting inflation down and has been pretty clear they’re willing to do whatever it takes to accomplish that. In fact, Fed economists are projecting a recession this year.
Moreover, Silicon Valley Bank’s collapse in March is another bad card on the table, as it injects more uncertainty into the economy and has led to tighter credit conditions. And there are always potential threats lurking — for example, a potential debt ceiling crisis out of Washington, DC.
“We’re seeing things slow, they can keep going in terms of slowing more,” said Claudia Sahm, the founder of Sahm Consulting and a former Fed economist. “The problem right now is when you look at the data, when you look out at the world, you can see the good scenario of we’re getting back to normal, we’re getting something sustainable, or we’re going to a bad place.”
A near-term recession isn’t a guarantee and could be avoided. The job market has proven quite resilient over the past year, despite the Fed’s best efforts. And the economy’s been so weird lately that, you know, stranger things have happened. Pretty much nobody (correctly) wants to make any predictions or hard declarations, and the default assumption here really is recession. But maybe, just maybe, we could see a soft landing.
“A soft landing is going to be tricky to pull off, but I think the initial descent is going well so far,” said Nick Bunker, the economic research director for North America at the Indeed Hiring Lab. “We’re still not on the ground yet, so I don’t think anyone should be throwing a victory parade.”
Let’s say the glass is half full here for a minute
I don’t think a lot of economists are waking up in the morning and doing a little dance thinking about how awesome the economy is and how it’s going to stay that way forever. But in a lot of ways, the current panorama isn’t terrible.
At 3.5 percent, the unemployment rate is as low as it’s been in decades, and the Black unemployment rate is at its lowest point ever. The labor force participation rate is by and large back to where it was pre-pandemic. Unemployment claims are ticking up, but they’re still low; the economy’s still adding jobs, but not as many as it was. People with disabilities and with criminal records have been pulled into the job market. Many low-income workers have reaped the benefits of a tight labor market.
Consumer spending has slowed, as have retail sales, but the bottom hasn’t fallen out. Many supply chain woes have eased. Most of the government supports put in place during the pandemic, which boosted the economy’s resiliency over the past couple of years, have been sunsetted. However, there are other potential stimuli in the mix, including the Inflation Reduction Act, the CHIPS Act, and the bipartisan infrastructure bill, all put in place under the Biden administration.
“We’ve really shored up our economy in a way that we haven’t done in many, many years, and we’re really reaping the benefits of that,” said Rakeen Mabud, chief economist and managing director of policy and research at progressive think tank the Groundwork Collaborative. “The labor market is in really good shape, and that’s all in spite of the Fed’s efforts rather than because of it.”
Ben Casselman at the New York Times recently explored the sort of fork-in-the-road moment the economy is in. He noted that a combination of increased supply in the labor force and generally reduced demand as hiring slows should let the labor market find some balance without having widespread layoffs, which is what appears to be happening for the time being.
He also spoke with Jan Hatzius, chief economist for Goldman Sachs, who noted that relative to where the economy was a few years ago, this is a pretty decent place to be. “Given the incredible downturn in the economy that we saw in 2020 — with obvious fears of a much, much, much worse outcome — if you actually manage to get back to a reasonable inflation rate and high employment levels in, say, a three- to four-year period, it would be a very good outcome,” he said.
Jerome Powell vs. inflation vs. all of us maybe
Inflation appears to be coming down, and it isn’t nearly as high as it was, say, a year ago. But at 5 percent over the past year as of March, it’s not at the 2 percent long-term target where the Fed wants it to be. Just how aggressive the central bank will be in getting there is the key factor in determining what happens to the economy next, and by all indicators, the Fed is going to be pretty aggressive.
The Fed has been hiking interest rates in an effort to bring down inflation and cool off the economy since March 2022. Fed Chair Jerome “Jay” Powell has acknowledged the road to getting prices back to normal will likely be long and bumpy.
The central bank is well aware of the dangers that come with hiking interest rates, including a recession and job loss, and it’s sticking to its guns anyway. What convinces it to change course is the real X factor here, said Skanda Amarnath, executive director of the advocacy group Employ America. “The soft-landing-hard-landing question is ultimately going to be about what facts persuade the Fed not to unleash certain recessionary consequences,” he said. “A soft landing does require Fed cooperation. We don’t have Fed cooperation right now with a soft landing scenario.”
Fed actions have already arguably had consequences, and their reaction to that is instructive. When Silicon Valley Bank and Signature Bank went under in March, it was in part a result of the Fed’s interest rate hikes (and some banks’ bad planning for it). As the saying goes, the Fed increases rates until something breaks, and it had broken SVB. There was speculation that the central bank might put a pause on further increases until the banking sector settled, which it did not. It upped rates a little less than expected, but it kept going.
The Fed didn’t change course because of banking chaos, meaning it may very well not change course in the face of more expected outcomes, such as labor market chaos or a recession. The Fed expects the unemployment rate to increase to 4.5 percent by the end of the year, which could add up to some 2 million people out of jobs. Minutes from the central bank’s March meeting show it expects a mild recession this year.
“If a recessionary scenario starts to emerge, they’re not going to lean against it,” Amarnath said. “They are telling you, if we do see a recession, if they see anything that might cause a recession, don’t expect them to stand in the way of it.”
Many of the effects of the Fed’s rate hikes haven’t yet hit the economy, so while the labor market might appear resilient now, that may not last.
“It could be that some of the economic effects, especially on the labor market, especially from interest rate hikes, haven’t been felt yet,” Bunker said. “Past decisions are potentially going to start catching up with us.”
“It’s way too premature to say, ‘Good job, Fed,’” Mabud said. As the Fed keeps hiking rates, assuming it does, the situation will become more precarious. “I would be optimistic if the Fed stopped raising rates, to be honest,” she said. “We are seeing some really positive signs, and I worry that with additional rate hikes that come down the pipeline, with the rate hikes that we already have in the system, that’s going to ruin the gains we’ve seen.”
Once things go south, they can do so fast, and there’s no guarantee when they’ll stop. Two million lost jobs, which is a lot of jobs, can become 3 million and 4 million and 5 million.
“We don’t have a lot of evidence of situations where the unemployment rate only goes up a little,” Strain said. “My reading of economic history is that when the unemployment rate goes up a little bit, it just keeps going up.”
A soft landing, if it happens, doesn’t mean a smooth landing
If we achieve a soft landing — and, again, that’s an if — and the economy cools off and inflation comes down without slipping into a recession, that doesn’t mean the process is going to be smooth sailing. The path is going to have some surprises, and some of those surprises will put that soft landing scenario at risk.
The fallout from the banking crisis remains unclear, and there’s a question as to whether the crisis itself is even over. In his 2023 annual letter in early April, JPMorgan CEO Jamie Dimon warned that the crisis is “not yet over, and even when it is behind us, there will be repercussions from it for years to come.” Also in April, billionaire investor Warren Buffett told CNBC he doesn’t think bank failures are over.
“Silicon Valley Bank surely is not the only badly run financial institution in the country. Even if we have no more banks fail, no more big ones, the effect that this has had on credit conditions is real,” Sahm said. “We’ve stopped throwing the big rocks, but after you’ve thrown them, there are ripples that come out from it.”
Fallout from the failures, like banks tightening lending standards and becoming more cautious about who they give loans to, is likely to slow the economy down, which could negate the need for the Fed to keep increasing interest rates. Treasury Secretary Janet Yellen said as much in a recent interview. The concern is that it rolls into a credit crunch, where banks really pump the brakes on lending. “If it’s severe enough, how the banks react in terms of their standards, if it really becomes too hard for businesses to borrow or really costly, a credit crunch would be the equivalent of a hard landing,” Sahm said.
Liz Ann Sonders, chief investment strategist at Charles Schwab, said she thinks the US is in a sort of “rolling” recession. Certain parts of the economy, such as housing, are contracting, while others, such as services, are not. Whether that ultimately translates to a broad-based recession or soft landing remains to be seen, but she’s not optimistic.
“Before what’s gone on in the banking system, probably the best-case scenario would not really be defined as a soft landing but one where, if the services side started to weaken, maybe the goods side would have started to stabilize and improve, and you would continue to see this roll through the economy without taking the economy down in aggregate to a degree such that it declared a recession,” she said. But now, with the banking system and the tightening she expects to see in credit conditions, “the rolling recession will roll into a formally declared recession.”
When it comes to what’s next for the economy, nobody has a crystal ball here … and if they did, they would be very, very rich. A soft landing may not be the most probable outcome, but it’s happened before, and it’s possible. And hey, plenty of people have been saying a deep recession is just around the corner for months now, and that doesn’t appear to have happened yet. Are we in the midst of a soft landing? The honest answer is it’s just too early to tell.
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