What Is a Soft Landing, and Can We Expect One?
If you follow financial news through any medium, you will no doubt have heard talk of a “soft landing.” What very few people who use that phrase seem to do, though, is define what they mean by it. That, using jargon that makes it difficult for outsiders to grasp the meaning of what you are saying, is something that is all too common in financial markets, as I found out years ago.
When I first walked into a dealing room as a young trainee years ago, the atmosphere was overwhelming. There was so much aggression, with people shouting at each other constantly, and the stress was so thick in the air that I felt it on my skin. Perhaps the most worrying thing, though, for somebody looking to understand the environment, was that it seemed like everyone was speaking a foreign language. It took only hours to divine the meaning of some of the more frequently used jargon, words like “mine” and “yours” and “bid” and “offer,” but other things, like the distorted version of cockney rhyming slang often used instead of numbers and other “inside jokes” language, took a lot longer to understand.
Before too long, though, I came to a conclusion that made the jargon less intimidating…it wasn’t confusing and hard to grasp by accident; it was supposed to be that way. The actual business being conducted was not that complicated. Everyone was trying to do something quite simple: sell things for more than they paid for them. They weren’t using any complicated math or any particular genius to do so, either. In theory, anyone could have done this. Making it seem and sound complicated kept it to those in the know, however, and thus kept their salaries and bonuses at sky-high levels.
Maybe that is a bit cynical. Maybe market participants spoke to each other in incomprehensible slang because it was fun, or convenient, or for some other innocent reason. But the fact is that to watchers, it made the users look much smarter than they actually were. I decided then that I would always try to explain what I meant when I used jargon, so I feel compelled now to offer up an explanation of a phrase that is heard multiple times whenever there is a discussion of Fed policy or the prospects for the U.S. economy. And "soft landing" certainly applies here.
A soft landing, in economic terms, is when economic growth slows, or even declines, in a fashion so orderly that a recession is avoided. That metaphor, seeing the economy as an airplane flown by the Fed, is then often extended to include talk of the “glide path” that the economy is on, or the possibility of a “crash landing,” or one that is bumpy but ultimately safe. Of course, that all presumes that the Fed is in complete control, which some may question. However, they do set short-term interest rates, which inevitably influences longer-term rates, and therefore the demand for credit, which fuels growth.
So, let’s assume that they are indeed “flying the plane” and stretch the metaphor a bit further. Even though a plane coming in to land is under the pilot’s control, there are things that can influence the landing that aren’t. A gust of wind, for example, could throw the plane off course, or there could be an oil spill on the runway, or some other obstruction. Similarly, for the American economy, events outside the Fed's control could alter the path of fiscal policy, such as action by Congress. There is also the possibility of an outside shock to oil or food prices, a war, or some other unforeseen disruption (like a worldwide pandemic).
So, with all of those caveats, how likely is it that we will get a soft landing this time around? Well, the data, as presented in this Alan S Blinder article for The Journal of Economic Perspectives, suggests that for all of Powell's efforts, and for all that everyone acts as if they are completely in control, the chance of this bout of rate tightening becoming a soft landing or a crash is a coin flip.
Since 1965, there have been eleven periods of rate hikes. Six of those eleven resulted in lower inflation two years later, indicating a success, while five have resulted in hard landings. There is no definable relationship between those two things, indicating that success or failure, however you measure it, is unpredictable and may be completely random.
While it is comforting to believe in a soft landing, that somebody is flying the plane and that the Fed’s actions will have a predictable, calculable outcome, the data suggests otherwise. The Fed is doing what they can, what has to be done even, but the chances of reaching the desired outcome -- controlled inflation without a damaging recession -- seems to be fifty-fifty at best.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.