Markets Brief: Will We Actually Avoid a Recession?

The U.S. economy making a soft landing seemed like a moonshot less than a year ago, but it’s now a distinct possibility, according to economists and analysts. Stocks and bonds staged an “everything rally” into early December as investors’ hopes for this ideal outcome took shape, with the Morningstar US Market Index climbing 5.4% over the past month.

A soft landing is a rare economic scenario in which a central bank raises interest rates high enough that it cools an overheating economy without leading to a recession.

Over the past two years, the Federal Reserve undertook one of its most aggressive rate-raising cycles in history to bring down runaway inflation. Now it’s faced with making sure monetary policy is just tight enough to keep inflation trending lower and growth at a healthy level, but not so tight that it chokes off the economy and sends it into a recession.

It’s a difficult needle to thread. Historically, despite its best efforts, the Fed has ended up raising rates to such a degree that economic growth turned negative.

But analysts say a soft landing is looking a lot more possible than most believed at the beginning of the year. Inflation is already moderating, as is economic growth, but the labor market is staying healthy, consumers are continuing to spend, and corporate earnings have recovered from a downturn.

“We’ve gone from many people saying [a soft landing is] impossible to it being widely recognized now,” says Preston Caldwell, chief U.S. economist at Morningstar. Some of that confidence comes from how the economy has made so much progress already.

Gregory Daco, chief economist at EY, says, “To a large degree, we’ve achieved” a soft landing. “Inflation is more or less in line with where the Fed wants it to be ... we still have an economy that is growing at a moderate pace.”

Jobs data released Friday showed that hiring remained strong in November, even amid interest rates that have reached 15-year peaks. This is a welcome sign for investors that the Fed is indeed on the right track.

Plenty more tailwinds remain for the economy. Strategists cite remaining excess consumer savings from the pandemic (albeit providing smaller cushions than before), the potential economic boost from artificial intelligence technology, continued improvement in global supply chains, and more.

Can We Really Avoid a Recession?

Of course, confidence in the best-case scenario doesn’t preclude plenty of variation among economic forecasts.

Caldwell says, “Whether or not [a soft landing] happens is still up for debate.” He’s in the no-recession camp, though he does expect growth to slow heading into 2024. Strategists from Bank of America are expecting a soft landing for 2024 as well, defining it as “a period of positive but below-trend growth.”

Over at Goldman Sachs, analysts say the economy has made “substantial progress” toward a soft landing. They wrote in the firm’s 2024 outlook last month that the problems of high inflation and an overheating labor market “look largely solved, the conditions for inflation to return to target are in place, and the heaviest blows from monetary and fiscal tightening are well behind us.” They peg the odds of a recession next year at 15%.

Chris Zaccarelli, chief investment officer at Independent Advisor Alliance, doesn’t think the U.S. economy will escape a recession. He’s also anticipating a more sluggish economic climate, but not in the immediate term. “We think the recession will ultimately happen,” he says, as spending slows and stress builds from the Fed’s rate hikes. But he’s optimistic that we’ll continue to see growth in the first and second quarters of next year. A recession is “farther off than you think,” he explains.

On the other hand, strategists from Wells Fargo are forecasting that the United States will fall into a mild recession in early 2024, though they consider this far from a guarantee. “Growth prospects remain dim,” Wells Fargo economist Shannon Seery Grein said during a November presentation for investors, “but a recession is far from certain at this point.”

Daco is somewhere in the middle. “When it comes to the outlook for 2024, we are on the fence,” he says. “The likelihood of headwinds or tailwinds dominating next year is fairly balanced.”

The Labor Market is Crucial for Economic Health

Daco says the trajectory of the labor market will be a major determinant for the economy next year. Employment has remained strong in 2023 as employers have retained talent, he explains, and that has prevented a sharp slowdown in economic activity thus far.

Zaccarelli also points to jobs as a crucial factor in the recession debate. When the unemployment rate rises, he explains, it’s an indication that consumers will stop spending. “That’s going to be the early warning sign for the next recession … we’ll see job losses before we see the slowdown in spending.”

“The labor market can be either a tailwind or headwind,” Daco adds. A slowdown in employment could lead to an economic contraction, while a stronger environment could insulate the economy against a downturn.

What Could Derail a Soft Landing?

There are plenty of other factors that could tip the balance. Strategists cite higher interest rates, tighter lending standards, and the potential lag effects of the Fed’s recent tightening as potential headwinds for next year’s outlook.

“There’s a sense that [the effects of] many of the Fed’s rate hikes have yet to play out,” Caldwell says, “and if they do play out suddenly, it could flip us into recessionary territory.”

Daco points to rising consumer costs for just about everything, and Bank of America strategists cite other risks to the consumer, like the return of student loan payments and rising gas prices. That’s not to mention the risk that the economy continues to grow too fast, Caldwell adds, which could prompt the Fed to keep policy tight for longer and trigger a recession, or the fact that a recession can be self-perpetuating once it starts since nervous consumers are even less likely to spend.

Will the Fed Cut Rates Soon?

All this will be top of mind for investors ahead of the release of the latest inflation data and the Federal Reserve’s last meeting of the year. It’s widely expected that the central bank will keep rates steady for now, but optimistic bond investors are already pricing in rate cuts as soon as March.

“It’s a tricky problem for the Fed,” Caldwell says, “and they’re probably not going to do it perfectly … but I think they’ll pivot in time to get us out of recession.”

For the Trading Week Ended Dec. 8

• The Morningstar US Market Index rose 0.2%.
• The best-performing sectors were communication services, up 1.1%, and consumer cyclical, up 0.9%.
• The worst-performing sector was energy, down 3.5%.
• Yields on 10-year U.S. Treasury notes rose to 4.23% from 4.22%.
• West Texas Intermediate crude prices fell 3.8% to $71.23 per barrel.
• Of the 847 U.S.-listed companies covered by Morningstar, 404, or 48%, were up, and 443, or 52%, were down.

What Stocks Are Up?

Dish Network DISH, Norwegian Cruise Line NCLH, and AMC Networks AMCX.

What Stocks Are Down?

Palantir Technologies PLTR, Plug Power PLUG, and Cava Group CAVA.