How Will The Economic Plane Land?
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The US economy has had an elongated cycle with several fakeouts thanks to the stimulative efforts in 2020 and 2021. Generally, after the Fed has hiked this far off of zero and kept rates there for several months, you'd have already seen a swift decline in economic activity. Still, apart from the localized slowdown, nothing has really hit the labor market or impacted GDP yet. As such, many have been baffled as to when the US economic plane will land, and that is what I'll provide an update on in today's post.
It's a recurring plotline in the financial world: the rise and fall of headlines about a "soft landing," referring to a slowdown in the economy, a return to 2% CPI inflation, without a contraction, CPI deflation and/or negative quarterly GDP growth. As the Fed hikes rates, these headlines start popping up more frequently, painting a picture of a smoothly transitioning economy.
Look at the chart below, with soft-landing headlines in white rising in tandem with the Fed's policy rate in orange. They hit their peak when the Fed finally hit the pause button on hiking rates, signaling to everyone that the landing might just be soft after all. But history repeats itself and each cycle ends with a recession with the Fed cutting rates to stimulate and offset pre-emptively in some cases, and responsively in all others. Headlines about the Goldilocks soft landing for the US economy may spike but they prove to be incorrect every time:
As the economic landscape begins to show signs of cooling off, a familiar pattern emerges in commercial real estate loans across the United States. Almost like a gathering storm, loan growth starts to lose its momentum, gradually forming a rounding top which I've marked on the chart below. It's a visual cue signaling a shift in capital investment sentiment, as loan growth stagnates and eventually transitions into a decline in total outstanding loans. This decline, mirroring the broader economic downturn, underscores a contraction in business activity and investor confidence, characteristic of impending recessions. Right now we're in the early stages of this rounding top as you can see with the slope of outstanding CRE loans declining, a harbinger of economic headwinds on the horizon:
The Conference Board's US Leading Economic Indicators Index serves as a vital barometer for the direction of the American economy. Comprised of ten key metrics that typically precede shifts in economic activity, this index aims to forecast the trajectory of the economy in the coming months. One of its most compelling attributes is its track record: a multi-month decline in this index has historically foreshadowed every recession in its recorded history. The term "leading" in its title aptly describes its predictive power, as it provides crucial insight into where the broader US economy is likely headed. Given its consistent performance as a harbinger of economic downturns, the current multi-month decline in the index signals a warning sign for policymakers, investors, and businesses alike, emphasizing the importance of closely monitoring its movements for indications of future economic trends.
Here is a matrix of economic analysts' expectations for GDP growth in the coming quarters, most notably analysts don't foresee a contraction in GDP at all. The closest we're seeing on the horizon to a contraction is the 0.5% QoQ print expected for Q2, and that's it. In stark contrast to economic data and leading indicators which point to a slowdown by all accounts, analysts think that it will be tame enough to not dip into official contraction territory:
The US Treasury yield curve paints a similar picture of will-they-won't-they ambivalence. An inverted yield curve means that front-end rates are higher than long-end rates, meaning investors are willing to take a negative term premium to hold longer-dated bonds over shorter-dated ones. Put simply, it means that investors are wary of the growth outlook in the United States, and want to own longer-dated bonds that stand to appreciate more when interest rates are cut. An inverted yield curve signals deteriorating growth expectations, and once a yield curve un-inverts, rate cut expectations in response to the deteriorating growth expectations take hold, and a recession ensues shortly after. Going with the theme of this first-of-its-kind economic cycle, this is the longest period of inversion for the 3m10s curve of all time, meaning the bond market is just as perplexed about the timeline of recession as analysts find themselves:
Still, analyst desks at banks like Goldman are raising their targets for the S&P 500 with each passing day to 5,200 on estimates of strong profit expansion, strong economic growth, and higher profits. This is after the Fed has embarked on its fastest rate-hiking regime of all time. Amidst all of this, risk-taking is still fully intact, to the credit of many banks and companies who insulated themselves properly and extended their debt maturity well into the decade:
I'll close out here with one final chart, soft landing headlines in white and recession headlines in orange. Time and time again, the cycle ends in the same fashion: hopes that this time will be different, followed by the cold reality that the incompetence of central planners and the destruction they wreak is inevitable. With weekly soft landing headlines having plummeted to nearly their lowest point this cycle, are we on the verge of a recession as previous cycles have seen? If this cycle is any indication, it's a fool's errand to guess. Keep an eye on March as banks and consumers come under more stress, that will tell us more about timing.
Final thought: we're in a holding pattern above the runway, please stand by.
Take it easy,
Joe Consorti
Theya is an app for simplified Bitcoin self-custody. With its 2-of-3 multisig custody solution, you can enjoy maximum security for your Bitcoin and the peace of mind that comes with it.
Download Theya on the App Store and declare your sovereignty today.