Last week, one investor wrote on LinkedIn that Fed chair Jerome Powell could be hailed as the “most successful and important central bank governor this country has ever had.”
High praise. Why?
If the U.S. economy can attain what pundits are calling a “soft landing,” which is when inflation steadily declines without major malfunctions in employment or the financial system, then Powell and the rest of the Fed team will have accomplished a heroic feat. They will have walked along the knife’s edge and returned unscathed.
On one side of the blade, Powell took office in 2018, navigating a 0 percent interest rate environment (and a volatile administration) that pumped up investment dollars based on cheap rates. That environment careened into the unprecedented COVID-19 era, with its money printing, inflation, and uncertainty. Leaving the status quo for too long would have created a dangerous situation of runaway inflation and destabilization.
On the other side, he began a campaign to make the economy a little more precedented by raising interest rates to cool a chaotic economy. So far it appears to be working. Whether he achieves a soft landing remains to be seen, but investors and economists watch with a hopeful eye.
What happened
A recent article in The Economist will catch readers up to the latest in the soft-landing debate:
Economists are not known for their optimism, but today their good cheer is palpable. Not long ago it seemed that an American recession was inevitable, as the Federal Reserve kept raising interest rates to fight inflation. Other central banks were following suit, their inflation problems made worse by a surging dollar—a particular problem for the emerging markets that borrow and trade using America’s currency. Yet news that America’s headline rate of annual inflation fell to 3% in June has fed hopes that the Fed’s next rate rise, which is expected on July 26th, will be its last and that other central banks might relax, too. Stocks are up, bond yields are down and the greenback is at close to its weakest since the Fed began raising rates.
News like this boosts consumer confidence. Recent polls reported in the Journal mark consumer confidence at the highest levels in years. But there’s an interesting plot twist: “In our measures, consumers are telling two different stories,” said Dana Peterson, chief economist at the Conference Board. “They’re saying, ‘Things are OK right now, but I think something bad is around the corner.’” The Journal article continues: “The views about the next six months, in fact, are so bad that they have typically signaled a recession,” Peterson said.
The bulls and bears are intensely wrestling over this point. Bulls believe that the market (or an individual company) will soon go up, and they invest on that basis hoping their asset values will increase. Bears, by contrast, argue that the market (or a company) will go down, and they preserve cash or sell short.
Some investors believe what we’re seeing now is a bull trap: As the market moves generally downward, for various reasons it has the potential of shooting upward, causing fools to rush in, after which the market turns downward again and causes painful losses.
Evidence comes in the form of one interesting statistic tweeted on July 18 by an influential investing newsletter: “The S&P 7, a handful of technology stocks, is now up an incredible 58% this year. Meanwhile, the remaining S&P 493 is up just 4%. AI hype and technology stocks are literally holding up the entire market. Markets really believe AI is the next big thing.”
Another macro investor posted on LinkedIn: “What about recession fears? Well, history suggests recession is still coming, perhaps in early 2024. The yield curve has never been wrong, but it has been early, as it appears to have been this time.”
Either way, another investor wrote that this past year has been a humbling one for economists. Uncertainty prevails.
Bears like me are waiting for the other shoe to drop—while also trying to avoid a bear trap.
Why it matters
The Economist article cited earlier notes three important reasons that economic hopes may be premature:
First, “inflation, though lower, remains far above central banks’ 2% targets.” The latest reading puts US inflation at 3%, while Britain’s is at near 8%. Second, “whereas the world is seeing the benefits of cooling off now, the costs may not be visible for a while.” Perhaps the job market hasn’t gotten as bad as it can get, and more fat remains to be trimmed. Third, “divergence among the world’s big economies means that even as the pressure on the Fed lifts, policymakers elsewhere remain worried.” See economic issues like rising inflation and falling growth in economies like Britain, Japan, and China.
Why does any of this matter except to economists and investors? Partly because these indicators eventually make their way into the “real” economy, where jobs are lost and hard-earned dollars spent at the grocery store are less valuable.
There are also stubborn political consequences. Next year is an election year. If inflation isn’t under control and job or wage growth isn’t humming along, that could reflect poorly on the current administration.
The people’s remedies to these issues, however, may result in even more damage. Poor economic conditions have ruined many presidential careers in the past. Think back to the last time similar macro forces were at play with the regime changes before and after Reagan, Thatcher, and the Soviet Union. Are we due for another shakeup? Nations around the world are currently seeing a rise in autocracy and populism, worrying analysts about a bleak political future to come.
But all is not lost. Our economy — indeed, the world’s economy — has had many ups and downs over the years and centuries. Its leaders have grown and waned in popularity and power, companies’ fortunes have ebbed and flowed, and empires have risen and fallen. This won’t be the last series of unusual events. God remains steadfast.
Remember that when the people around you are grinning or grumbling. Make the best decisions you can given the limited information available to you, and get back to work.