Throughout 2022, investors have seen various positive economic developments as signs that the Federal Reserve Board was ready to pivot and end—or considerably scale back—its rate hikes.
In every case, they’ve run into a Fed that insists it still has plenty of work left to do to crush runaway inflation.
But hope springs eternal. The equity market’s most recent upswing has been fueled partly by investors’ burgeoning belief that the Fed will steer the economy to a true soft landing—taming inflation without causing painful unemployment or a full-on recession. Indeed, some leading indicators suggest a slowdown in inflation, and investors were heartened by Chairman Powell’s comments last week that the pace of interest rate hikes could slow as early as this month.
One result: Based on Eurodollar futures, the market is currently looking for almost six 25-basis point interest rate cuts in 2024. That would represent a swift reversal of the restrictive monetary policy investors have feared all year. Indeed, such a pivot toward supportive policy may be enough to stave off what is fast becoming a consensus recession call next year.
Trouble is, soft landings are hard to come by. According to research by Alan Blinder1, former vice chair of the Federal Reserve, the Fed’s policy moves accomplished his definition of a “perfect” soft landing just once during the 11 times it raised rates from 1965 into 2019. In that single period—from the end of 1993 to April 1995—inflation hovered around 3%, real GDP did not decline, and unemployment remained at what was believed to be its natural rate at the time.
The good news: Blinder points out that most of those 11 periods saw relatively soft (but not perfectly soft) landings, with mild to moderate recessions. Ultimately, however, investors who expect the economy to come out of the current environment unscathed don’t have history on their side—and might be, once again, too sanguine about the future.
Alan Blinder. “Alan Blinder on Landings Hard and Soft: The Fed, 1965-2020.” Princeton University. February 11, 2022.
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