The economy is at the point when the flight attendant says, “please make sure your seat backs and tray tables are in their upright and locked position.” (UBS)

So this is it, the final stretch of the “landing.” Regardless of what 3Q GDP tracking estimates say, inflated as they are by Barbenheimer, Taylor, and Beyoncé, the US economy is slowing. The most compelling and relevant evidence for that claim is from the labor market, and the data last week makes it hard to dispute. Monthly job growth has been gradually declining for more than two years, while the fall in job openings appears to have picked up pace. Other data tell a similar story of a cooling labor market. Given these trends, any thoughts of a “no landing” can be put to rest.

The essential investment question remains, “what sort of landing should we expect?” We’re in the soft-ish landing camp. But why is this the final stretch to a landing? To answer, it’s first necessary to define a soft landing, a subjective semantic exercise. It’s not controversial to say that a soft landing entails no recession. The subjectivity is over the horizon to which this applies. My view is that if the Fed is done hiking and inflation is still falling by year-end, while a recession is not imminent, then the economy achieved a soft landing. A recession that starts late in 2024 is not a hard landing, that’s a late-cycle economy that fell into recession. If restrictive monetary policy is primarily to blame, then the Fed made a policy error by keeping rates too high for too long when it could have cut earlier in the year.

Based on this definition, the answer to what sort of landing should be much clearer by year-end. The Fed may already be done hiking rates—the market is pricing 40% probability of another hike by November. With three more FOMC meetings before year-end, it would be surprising if the Fed wasn’t done by then, and indicated as such. Uncertainty resides more with inflation and growth. Fading base effects, health care price adjustments, and an expected temporary rise in month-over-month inflation could cloud the disinflation story. Meanwhile, consumer spending should cool after a hot summer, though it could be partially offset if the manufacturing sector starts to inflect higher, a possibility with the ISM index looking like it has bottomed out. Most important is whether labor market cooling stabilizes at a monthly job growth rate around 100,000 by year-end, or slips near contraction territory.

To squeeze everything out of this landing analogy, the economy is at the point when the flight attendant says, “please make sure your seat backs and tray tables are in their upright and locked position.” Federal Reserve Chair Jay Powell won’t say that during his FOMC press conference on 20 September. Instead, he’ll likely say that more work is necessary to be sure that inflation returns to the 2% target, but also that the risks to the economy are becoming two-sided. He’ll also say that their decisions will be data-dependent, and thus not on auto-pilot. That means another hike is possible, but the bar for that to happen is getting higher.

Defining a soft landing and the criteria to determine whether one has occurred is not just a mental exercise. For as much as a soft landing has become the consensus view, positioning still indicates some caution, as if investors don’t fully believe what they’re saying. Instead, they need to be convinced that the Fed is done hiking rates, that disinflation will continue, and that growth is not about to imminently roll over. All of that should materialize in the final months of the year.

The bottom line: Evidence in the coming months for a soft landing should eventually be positive for risk assets, but the final approach to the landing won’t be without turbulence for data-dependent markets. It’s why we expect a soft-ish, rather than soft, landing. It’s also why bonds are our most preferred asset class, buying high quality bonds at current yields is attractive, and equity laggards offer a better risk-reward than the overall equity market. Regardless of your view on the landing outcome, it’s safe to say that all investors would welcome moving past this seemingly endless debate by year-end.

Jason Draho, Head of Asset Allocation, CIO Americas

Original report: Seat backs and tray tables , 5 September, 2023.