Is a soft landing upon us?

It’s starting to look like the US Federal Reserve might’ve done the impossible, or at least the very rare.

A “soft landing” is always the goal when a central bank embarks on an interest rate hiking cycle to knock inflation on the head.

There’s no official definition, but that generally means getting price increases under control without causing a recession or major economic slowdown in the process.

To achieve that, policymakers need to ensure unemployment doesn’t rise too much, even though they’re actively trying to constrain activity.

It’s a difficult needle to thread, and central banks have a mixed track record.

Most of the time, when interest rates rise sharply, a recession follows.

There are a few exceptions, such as the US hiking cycles of 1984 and 1995.

However, things were different then.

Interest rates didn’t rise as much as they have in the past two years, and inflation wasn’t nearly as high to begin with.

Fed Chair Jerome Powell has also suggested the Fed was on course for another soft landing in 2020, before COVID-19 threw a spanner in the works.

We’ll never know for sure, but that might be true.

The Fed had already started cutting rates in mid-2019 and it may well have acted early enough to avert a naturally occurring recession, had the pandemic not hit.

If we give the Fed the benefit of the doubt there, that’s three times in the past 50 years.

In contrast, I count six examples of the Fed hiking interest rates in the hope of taming inflation, but recessions following soon after.

Despite history being against it, several recent indicators suggest a successful touchdown might be looming.

The Feds preferred inflation measure, the personal consumption expenditures (PCE) price index, has fallen back below three per cent.

If we annualise the average of the past six months (to gauge the more recent trend), it’s sitting at two per cent at both the headline and core level.

That’s bang on Fed targets.

At the same time, the US economy has held up well.

Economic growth for the December quarter came in above forecasts, while the unemployment rate has been below four per cent for 24 consecutive months.

Early indicators suggest this strength has continued into this year too.

The resilience of the US economy has surprised a lot of people.

PCE inflation and unemployment in the US

There was always a chance the usual signposts wouldn’t prove as reliable this time around, due to uniqueness of the last few years.

Maybe pandemic-induced supply-side challenges were a much bigger factor than rampant demand all along.

While some will caution us about a potential resurgence in inflation, the evidence so far says the job is done.

If that’s the case, there’s no need for these high interest rates to overstay their welcome and cause an unnecessary recession.

Many indicators are giving the Fed the green light to start easing policy settings soon, and it would be wise to listen.

For investors, this will make for a much more attractive backdrop.

It could mean markets perform better than many expect from here, and that the long-awaited collapse in prices some have been calling for might not come.

If that’s the case, those patiently waiting for that lucrative buying opportunity to emerge might find themselves left behind.

It might be time to acknowledge what could go right, just in case the Fed’s done the unlikely and pulled this off.

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