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Is the US heading for a hard landing?
With annual inflation running at 9.1 per cent, a 41-year high, and a raft of Federal Reserve rate rises to follow, the risk of a hard landing for the US economy has risen sharply. A growing chorus of economists has given up hope that the Fed will be able to engineer a soft landing given its latest predictions. At the last Fed meeting, officials were more than willing to raise interest rates significantly to get inflation under control, recognising that the failure to curb inflation now would be even more disastrous later.
Erik Weisman, chief economist and portfolio manager at MFS Investment Management, says “the jury is out on whether the United States economy will be able to avoid a hard landing. We believe the probability of a recession has risen considerably, reflecting concerns over the threat of policy over-tightening by the US Federal Reserve.”
Looking at the above Fed funds rate projections curve, interest rates are tipped to exceed the 2.6 per cent estimated “neutral” rate by a significant margin. And it all boils down to the Fed’s mandate, which chairman Jerome Powell has made abundantly clear is containing inflation, rather than managing economic growth.
Weisman adds, “as such, the Fed has signalled that it stands ready, if necessary, to engineer a recession, in its unconditional fight against inflation. Should a hard landing materialize, it is likely the Fed would change gears and re-engage in policy easing, but only if inflationary dynamics are safely back in the box. Overall, the US economy is facing a period of significant volatility and uncertainty, and there is a wide range of potential outcomes.”
However, there is hope for a soft landing; but that window is closing. Avoiding a recession will require some supply constraint relief and a balance between strong consumer spending and rising rates. The issue, however, is that consumer spending is at historic lows and forecasts show it will only get worse. There is little evidence that shows inflation is coming off and the Fed will need to witness a clear change in trend with core inflation before it decides to take its foot off the pedal.
What are the implications for the fixed-income markets?
Weisman points to the fact that a recession is now more than likely, which means that rates should stabilise over the longer term. However, short-term rates may remain susceptible to continuing high inflation. He says, “If macro-economic fundamentals continue to deteriorate and a recession does materialize, we expect a widening of credit spreads, which will require careful analysis and security selection to help manage credit exposures.”
