Delayed Landing

Practically since the start of the Covid-19 pandemic in 2020, the professional forecasting community has been continually wrong about the the path of the U.S. economy, inflation, and Federal Reserve policy.

The latest collective mistake has been underestimating the strength and resilience of the labor market and economic growth after a year of sharp monetary policy tightening. 

Megan Cassella explored what everyone got wrong about the economy, and the implications for the Fed, in Barron's latest cover story:

Understanding the strength of the past year, and what has fueled it, is critical to charting the economy’s path forward. The simple answer is that it’s impossible to apply old rules to a new economy, one that has been completely—and permanently—transformed by the Covid-19 pandemic and no longer responds in the same way to rising prices and tighter monetary policy. 

The long tails of fiscal stimulus, for example, have propped up the economy for far longer than anyone expected. Excess consumer savings and an ebullient labor market fueled demand for travel, restaurant dining, and other services, where spending still has room to grow. And years of low interest rates have transformed the debt dynamics for the overwhelming majority of U.S. households, leaving them largely shielded, through fixed-rate mortgages, from the impacts of the Federal Reserve’s primary tightening tool.

The result is an economy that has yet to fully react to the policy tools designed to slow inflation, which more often than not have forced a recession.

The recent spate of positive economic data has fueled hopes of a “no landing” scenario, rather than a hard or soft landing, in which the economy continues to expand. But a more realistic outlook is less benign: Interest rates are likely to stay higher for longer to tamp down stubborn price growth, probably forcing at least a mild downturn along the way.

The 'no landing' scenario doesn't really mean no landing, ever. It should really be called a 'delayed landing,' Megan argues. The downturn is still coming, but forecasters keep pushing out the timeline for when they see a contraction starting.

A smooth slowdown to a 2%-inflation economy is still possible, but there's another risk to consider. The latest economic strength could mean the Fed has to work even harder and tighten policy even more to see the economy begin to cool the way it wants. Flying blind into an uncertain outlook, officials could easily go too far and prompt an even deeper recession.

Read the rest of Megan's piece here. And read about how to invest for continued growth today and a slowdown tomorrow here.