Credit Sesame discusses the possibility of an economic soft landing for the United States.
A soft landing is often discussed as the ideal solution to the economy’s problems. It has the potential to cool inflation without plunging the economy into a serious recession. However, it is a tough trick to pull off.
For much of the past year, the economic soft landing has played a game of now-you-see-it-now-you-don’t. When the economy first recovered from the pandemic, growth was so fast that it sparked inflation. Then, when inflation was cooling, economic growth seemed to slow too quickly.
For a brief period during the fourth quarter of last year, economic growth and low inflation seemed to be on track for a soft landing. It wasn’t long before things veered off course as inflation heated up in early 2024.
In the last week of April 2024, there were new signs of hope for the soft landing scenario. However, if it happens, there are also risks.
The US economy has lost momentum
Oddly, the good news is that the economy has lost much of its momentum. In late April 2024, the Bureau of Economic Analysis announced that GDP grew at an inflation-adjusted annual pace of 1.6% in the first quarter of 2024. That’s significantly slower than the pace of growth in the second half of 2023.
The Conference Board’s Leading Economic Index (LEI), which indicates the economy’s future direction, also shows signs of slowing. The LEI declined in March 2024 after rising slightly in February.
Given that economic growth has been largely fueled by consumer spending, this slower pace is no surprise. Personal savings rates are low, and credit card late payment rates have increased over the past year. In short, the primary source of economic growth is showing signs of being tapped out.
It may seem strange to celebrate slower economic growth. However, in the context of persistent inflation, slower growth could have benefits. At the same time, it’s also important to recognize that slower growth poses some risks.
The potential benefits of slower economic growth
The primary benefit of slower growth in this situation is that it could cool down inflation. After nearly disappearing in the fourth quarter of 2023, inflation has bounced back in the first three months of this year.
Given inflation’s tendency to feed on itself, that’s cause for concern. Slower growth would take the edge off demand and force retailers to offer better deals to price-conscious consumers.
As consumers rein in spending, they would have an opportunity to pay down debt. With consumer debt higher than ever and late payments rising, paying off some of those debts would take some of the risks out of the economy.
A slowdown might also calm some of the speculation in the financial markets at a time when investor enthusiasm seems to have gotten far ahead of reality. Over the past 18 months, the S&P 500 has risen by 46.5%, while earnings on the underlying stocks have increased by just 3.29%.
One example of speculative thinking and the risks it creates is the recent hit that Meta, the parent company of Facebook, took in the stock market. Much of the stock speculation centers around the potential of Artificial Intelligence (AI). Tech stocks like Meta have been the primary beneficiaries of enthusiasm for AI. However, when Meta CEO Mark Zuckerberg recently announced that the company was going to boost its spending on AI, the stock plunged by 10% in one day. It seems investors were counting on reaping the benefits of AI without the actual cost of developing new products based on it.
This kind of unrealistic thinking creates risk in the financial markets. A slower-growth environment might take some wind out of an overblown market.
Potential risks of slower growth
A slower growth environment would also carry some risks. Growth could slow too much, causing a downward spiral. For example, if the economy slows so much it shrinks, it could enter a recession. That would almost certainly cause unemployment to rise. As consumers lose income, growth would slow even more, possibly worsening the recession and unemployment.
Given the precarious state of consumer credit, that could accelerate debt defaults, putting the financial system at risk. A recent assessment of economic risks by the Federal Reserve identified default on both consumer and commercial debt as a concern. Rising interest rates have already made it more difficult to service much of this debt.
The kicker is that even a downturn this severe might not accomplish the goal of calming inflation. Even with a fall-off in demand, military conflicts and rising tariffs could create shortages of key goods. Over the past year, the housing market has been a perfect example of how supply shortages can cause prices to rise even in the face of weak demand.
Given all this, the Fed standing pat at the conclusion of its meeting on May 1, 2024, should be no surprise. The Fed has concerns about economic growth and inflation, and with so much uncertainty on both fronts, the best policy now may be to wait and see how things develop.
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Disclaimer: The article and information provided here is for informational purposes only and is not intended as a substitute for professional advice.
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