Can the Fed deliver a soft landing?
With its mid-cycle adjustment, the Federal Reserve has halted conversations about an impending recession, but analysts aren't convinced the U.S. central bank will deliver the elusive soft landing.
The chances of a U.S. recession in the next 12 months is between 25% and 30%, down from 30%-35% in August, according to S&P Global.
“With U.S. stock prices near all-time highs, equity investors have already positioned themselves for a soft landing for the U.S. economy and an acceleration in earnings and economic growth next year,” said Scott Anderson, chief economist at Bank of the West.
Encouraging news about a first phase of a trade deal with China, the Fed on hold after three rate cuts and the Dow Jones industrial average climbing above 28,000 all boosted the optimism. But while the stock market has gained, he said, “it is important to remind ourselves that the stock market isn’t the economy.”
While business investment and exports remain weak, “we have seen more concerning signs that consumer spending, the last leg of the stool supporting the U.S. economy, may no longer be on solid ground.”
Big-ticket item sales have “plunged since May,” Anderson said, and consumers, who have been fueling the economy, “also appear to be cutting back sharply on discretionary spending, like visits to full-service restaurants. This is usually one of the first areas where consumers pull back when budgets get tight. In this category, consumer spending hasn’t been this slow since 2010.”
It’s the consumer, not stock prices, that will determine the economy, he added, and there is “no guarantee of a soft landing for the U.S. economy in 2020.”
“The possibility of a soft landing is certainly rising,” said Steven Friedman, senior macroeconomist on MacKay Shields’ Global Fixed Income Team. “The monetary policy stance is now slightly accommodative, there are signs that the manufacturing recession is bottoming out, and spillovers to the services side of the economy have been relatively limited. The main risk to the near-term outlook, however, remains a re-escalation of trade tensions with China.”
Despite the rising odds of a soft landing, he warned, “the U.S. economy exhibits late-cycle vulnerabilities that will keep recession risks elevated going forward. These include high levels of corporate leverage, and rising labor costs that are cutting into corporate profit margins. In fact, these vulnerabilities would only increase over time if there is a soft-landing in 2020.”
While economic data have been better than feared, according to Karissa McDonough, fixed income specialist at People's United Advisors, they haven’t indicated “a strong upswing either, producing a retracement of the recent selloff in core bonds.”
The bond market no longer signals “a near-term chance of a monetary policy-induced recession,” as the front end of the yield curve is no longer inverted. “Repricing has been consistent with a dovish Fed,” she said. “Inflation expectations and equities are rising and the curve is steepening.”
McDonough said, “The Fed did a masterful job of easing and pausing at just the right time in order for the market to price out previous recession and policy error fears.”
Based on three-month, two-year and five-year Treasury yields, “the market doesn’t believe the Fed needs to ease soon or even over the medium term.”
Monday’s incoming data showed some weakness. The Texas Manufacturing Outlook Survey showed contraction for the first time since June 2016, as the production index dropped to negative 2.4 in November from 4.5 in October.
“Other measures of manufacturing activity were also negative in November, suggesting declines,” according to the survey. “The new orders index remained negative for a second month in a row, coming in at negative 3.0. The growth rate of orders index pushed further into negative territory, falling from negative 5.9 to negative 9.3. The capacity utilization and shipments indexes turned negative after three years in positive territory, falling to negative 5.3 and negative 4.5, respectively.”
The general business activity index narrowed to negative 1.3 from negative 5.1, suggestion slightly worse perceptions of broader business conditions.
Meanwhile, the Chicago Fed National Activity Index widened to negative 0.71 in October from negative 0.45 in September, suggesting slowed economic growth. The three-month moving average, CFNAI-MA3, fell to negative0.31 in October from negative 0.21 a month earlier.
The CFNAI Diffusion Index, also a three-month moving average, crept to negative 0.22 in October from negative 0.24 a month earlier.