Now there’s a new wrinkle to the analogy, the possibility of “no landing”. What exactly that means is debatable, but the gist of it is that the economy doesn’t appear to be slowing and is likely to stay in the air longer than had been expected. Presumably, no-landing is just delaying the actual landing, which could still be soft or hard.
Yet the longer a plane flies at 30,000 feet, the greater the chance that it hits turbulence and bumps around, sometimes violently, making for a scary ride and increasing the risk of a hard landing. That’s what it might feel like for investors navigating financial markets during this no-landing phase. Surprising data, such as higher-than-expected inflation, that makes investors question their assumed flight path for the economy is tantamount to a patch of turbulence. It’s not fun, and we don’t know how long it will last. Further complicating matters is a data-dependent Fed, which is another way of saying that they don’t know if we’re going to hit more turbulence and be forced to alter their landing plans.
Putting it in market terms, the economy hitting turbulence while flying at 30,000 feet forces investors to reassess their outcome landing probabilities, with price action reflecting this recalibration. The challenge is determining whether the turbulence is course-altering or just unpleasant bumps along the way to the same final landing destination.
That’s the question investors have been asking the past two weeks. Soft-landing hopes were fueled early in 2023 by signs of rapid disinflation, global growth expectations being revised higher, and central banks close to pausing rate hikes. But recently both growth and inflation data have been hotter than expected. This spurred the no-landing conjecture, and fears that sticky inflation will force the Fed to hike rates more than they currently project, increasing the risk of a hard-landing. Yet it’s also fair to be skeptical of the data quality because start-of-year seasonal adjustments are proving to be quite significant, and maybe misleading.
All this means that it will likely take at least two to three more months of data for investors and the Fed to get comfortable seeing through the turbulence and gaining conviction on the eventual landing path. For now, investors should first recognize that the distribution of macro outcomes for the US economy looks relatively flat with fat tails. Perhaps that’s an inevitable consequence of flying at 30,000 feet, where almost any terrain can look fairly flat and the horizon looks infinite.
One benefit of this high elevation is that it affords investors a big picture view of financial markets. It also makes clear that growth and inflation, and their resulting influence on monetary policy, are often the most relevant market drivers over the business cycle. Identifying the inflection points of these macro variables is thus critical and central to our 2023 outlook, even if doing so is difficult due to the data turbulence.
The bottom line: There are multiple combinations of growth and inflation trajectories that could occur on the way to whatever landing the economy ultimately experiences. But with some confidence we can say that US growth and inflation rates should both fall from their current levels during 2023, with the main uncertainty being over just how much. Historically, in macro environments of falling growth and inflation, high quality bonds have typically performed well, while equities and riskier credit produce low or negative returns. This is consistent with high-grade and US investment grade corporate bonds being among our most preferred asset classes, while US equities and US high-yield corporate bonds are both least preferred.
Main contributor: Jason Draho, Head of Asset Allocation, CIO Americas
Content is a product of the Chief Investment Office (CIO).
Original blog – Turbulence, 21 February, 2023.