The Future of the Economy: A Soft Landing or Hard Fall?

A version of this article originally appeared on the Research Affiliates website.

The current economic environment presents a puzzling scenario. Job growth is strong, yet reports of layoffs at high-profile companies are rampant. The inverted yield curve implies a looming recession, while the stock market remains at record highs.

Amidst these conflicting signals, can the economy achieve a soft landing with slower growth or a mild recession, or is a hard landing and a severe recession inevitable?

If the US Federal Reserve acts promptly and other mitigating factors remain in place, there is still hope for a soft landing. However, numerous pieces need to fall into place for this to happen.

The historical track record of the inverted yield curve serves as a cautionary indicator. Since the 1960s, it has accurately predicted eight out of eight recessions without a false signal. The recession forecast for 2023 based on the inverted yield curve needs to be taken seriously.

With the yield curve pointing to significant growth slowdown in 2024, the possibility of a minor recession, even in a soft-landing scenario, cannot be dismissed. To avoid a deep recession akin to the GFC, proactive measures are crucial.

It is essential to focus on crucial economic factors and potential headwinds:

Four Headwinds

1. Consumer Behavior

Consumer spending, a vital component of economic growth, was fueled by pent-up demand and government support in 2023. As consumer savings diminish, spending may contract, impacting GDP growth.

Investment, on the other hand, may already be in a recessionary state due to negative year-over-year trends. Monitoring consumer saving indicators and loan delinquencies is crucial to predict future spending patterns.

2. Credit Conditions

Low-interest rates offered by banks indicate bank weaknesses and signal tightening credit conditions. Consumers shifting to money market funds for higher returns may reduce bank lending capacity, affecting consumer and business spending.

The movement of assets to higher-yield funds and the implications of credit tightening must be closely monitored to gauge economic repercussions.

Yield Disequilibrium

3. Commercial Real Estate (CRE)

Structural changes brought by WFH norms post-COVID may impact Commercial Real Estate (CRE) markets. With remote work becoming prevalent, office space demand might decrease, posing challenges for CRE owners and financiers.

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The CRE market’s challenges are set to become more pronounced in 2024. Monitoring the sector’s dynamics and potential impacts on financial institutions is crucial to mitigate risks.

4. Interest Service Obligations on Government Debt

High government debt and escalating interest service obligations pose significant economic challenges. As interest rates rise, the burden of servicing debt increases, potentially impeding economic growth.

Effective management of debt obligations and prudent fiscal policies are essential to navigate the economic landscape and prevent a severe recession.

Three Tailwinds

1. Excess Labor Demand

Despite slowing growth, excess job openings compared to job seekers provide a buffer against a surge in unemployment. This labor market dynamic could mitigate the impact of an economic slowdown.

2. Housing

The housing market’s resilience, with consumers and banks holding more equity than debt, offers stability amid economic uncertainties. A potential housing price decline is unlikely to lead to a foreclosure crisis similar to the GFC.

3. The Prophylactic Impact of the Yield Curve

The yield curve inversion, a reliable indicator of economic downturns, prompts risk management actions by businesses. This proactive approach can lead to leaner operations and better resilience during economic slowdowns.

The Fed Is the Risk

The Federal Reserve’s monetary policy decisions play a crucial role in economic outcomes. Actions taken by the Fed, including interest rate hikes and inflation management, can impact the economy significantly.

Adjusting monetary policy based on real-time data and economic indicators is essential to avoid missteps that could lead to deeper economic downturns.

US Federal Reserve Overshooting