© Reuters
By Yasin Ebrahim
Investing.com – As debate rages over whether the Fed will be able to engineer a ‘soft landing,’ lowering inflation without a big economic hit, or a ‘hard landing,’ rising too high and pushing the economy into recession, a third scenario is making its way into the conversation: ‘No landing’.
In a ‘no landing’ scenario, the US economy does not slow down. Inflation remains above trend. And the Federal Reserve is being forced not only to raise rates more than expected, but to keep them higher for longer.
The uncertainty prevailing in this scenario is not likely to be fertile ground for risky assets to flourish.
The no-landing scenario risks bringing back the “volatile market action we saw in 2022 because it reintroduces uncertainty about inflation and about the Federal Reserve,” Apollo Management’s Torsten Slok said in a report.
The “explosive” January jobs report, says Morgan Stanley, has played an important role in stoking “the discussion about the possibility of a ‘no landing’ scenario.”
The recent jobs report, showing solid job gains and a five-decade low of 3.4%, dealt a blow to bets on a near-term recession, but also signaled concerns about upside risks to inflation that would likely spur the Fed to go further in raising rates and keep policy tighter for much longer.
“The more resilient the economy, the more the Fed has to chase,” Morgan Stanley added, though he stuck with his base case of a soft landing.
Traders are currently pricing in at least an additional quarter-point hike, while the odds of a May rate hike are gathering strength, according to Investing.com.
But the risk is that “this tightening cycle is not just about one more, two more, three more increases of 25 basis points, but something more fundamental,” former Treasury Secretary Lawrence Summers said in an interview with Bloomberg, citing upside risks to inflation.
Right now, however, investors continue to believe in the goldilocks, or soft-landing, scenario, which has helped risk assets start the year strong, despite this week’s wobble.
“Our long-standing call that the US economy would experience a soft landing this year became a consensus, Morgan Stanley said, adding that a ‘no landing’ scenario, while not clearly defined, looks more like a soft landing. .
“Our conversations suggest that the phrase is not clearly defined and tends to gloss over the political implications, but it seems more like a soft landing,” he added.
Still, a tougher ride for inflation at a time when markets are betting against the Fed, albeit with much less determination than in previous months, and the central bank has been keen to highlight that the disinflation process has begun, it would jeopardize the credibility of the Fed and stimulate new uncertainty.
“That would put the Fed in a really difficult position,” Zhiwei Ren, managing director and portfolio manager at Penn Mutual Asset Management, told Investing.com’s Yasin Ebrahim on Tuesday.
The Fed is now talking about disinflation, but in a few months, if we have higher inflation, they may have to change their rhetoric again and that will affect their credibility,” Ren added. “I think that’s the biggest risk.”
Signs are already emerging that disinflation, driven mainly in the goods sector, may prove temporary.
Used car prices unexpectedly rose 2.5% last month, the most since late 2021, though that was fueled by unusually strong demand, according to Cox Automotive.
Still, a ‘no landing’ scenario is likely to continue to infiltrate the outlook conversation for the economy, as data over the next few days is expected to show resistance and be bullish.
“The Fed fighters haven’t been doing so well lately and they may not find much support from this week’s events either,” Scotiabank Economics said.
“US headline CPI inflation is likely to rise higher, core inflation is expected to remain resilient and markets may have to reassess how they prematurely wrote off the US consumer earlier in the year as We are preparing for a strong retail sales impression.” he added she.
