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Investors are betting on a soft landing — a successful effort by the Federal Reserve to pare back inflation without sparking a recession — based on strong economic data and hopes that interest rate cuts are imminent.
But Wall Street could be getting ahead of itself: History proves that investors would be well-advised to remain cautious this year.
The good news: Recession fears were widespread at this point last year, but economic growth in the US has proven resilient.
Inflation is easing and is closer to the Federal Reserve's 2% target than it has been since the beginning of 2021. Policymakers are forecasting that interest rates are restrictive enough to begin cutting them this year.
The Fed has hiked rates 11 times in the past two years, but the unemployment rate has consistently remained below 4%.
Excess pandemic-era savings, meanwhile, have lasted longer than many economists predicted they would. That means consumers are still spending money and are feeling confident about the future. Their optimistic outlook helped trigger a huge market rally in the second half of last year, lifting the S&P 500 by 24% in 2023.
Economists are eager to say the US has brought inflation rates down while avoiding recession and to declare an official soft landing.
US Treasury Secretary Janet Yellen said last Friday after another month of strong employment numbers that "what we're seeing now I think we can describe as a soft landing."
That's a shift from Yellen's previous statements where she hedged her economic assessment, stating that a soft landing was only "possible."
Historically, there's a long lag before elevated interest rates take their toll on the economy, said Jim Reid, Deutsche Bank's head of global economics, in a note this week. Six out of the past 13 cycles saw the economic impact become most visible between 19 and 28 months after the first Fed hike, he found. That means a recession before the end of 2023 would have been quite early.
Based on empirical evidence alone, said Reid, the risk of recession is higher today than it was in 2022 or 2023.
The bad news: Soft-landing talk is not unusual ahead of recessions, said Reid. His team found that mentions of a soft landing in Bloomberg articles spiked significantly ahead of the 2001 and 2008 recessions.
Sure, past performance does not guarantee future results, but there are other omens.
The spread between the yields of the 2-year and 10-year US Treasury notes have been inverted since July 2022. When long-term bond yields fall below short-term bond yields it means that investors are more nervous about the immediate future than the longer term. These types of inversions have preceded each of the last 10 recessions in the US.
And while the US consumer remains resilient, Deutsche Bank data shows that credit card delinquencies are at their highest rates in more than 12 years.
Geopolitics, meanwhile, are tense. Russia's war on Ukraine, the conflict in the Middle East and attacks on shipping in the Red Sea have led to what JPMorgan CEO Jamie Dimon calls "maybe the most dangerous time the world has seen in decades."
Another political fight to avoid a US government shutdown is also possible this year, and the country is still running a historically large budget deficit.
Let's not forget that it's also a presidential election year in the US.
And yes, the S&P 500 rallied last year, but that's largely due to the power of the Magnificent Seven — the tech giants including Apple, Amazon, Alphabet, Meta, Microsoft, Nvidia and Tesla, that make up the majority of the index and that collectively soared well over 100% in 2023.
In short: There's a lot going on, and any outcome is possible.
"The data in front of us heavily points to a soft landing. At this stage of the cycle it typically tends to do so," wrote Reid and his team. "A big decision to make for 2024 is whether to follow the data or follow history."
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