Timing and the Fed — A Balancing Act

What Kind of Landing Should We Expect?

I was recently listening to Vildana Hajric and Isabelle Lee of the What Goes Up podcast. The whole balancing act between inflation and monetary policies is the focus of market participants and hence the never-ending conversation about “hard,” “soft,” or “no” landing. What strikes me the most is that I have yet to hear any moderator, interviewer, or speaker reference the exact timing of their position. When someone says no landing, one should immediately follow up with, “over what period?”

It is safe to say we are in the “no landing” scenario now (with good Q4 GDP, Jan U3, etc.) and will then go through a period that seems to be a “soft landing” as the economy and headline CPI both continue to cool. Ultimately, we will end up in a “hard landing” (economic contraction), which marks the end of this economic cycle.

Suppose one uses “landing” discussions to anticipate or frame Fed’s monetary policy path. In that case, the whole conversation should be centered around confidence in the Fed’s conviction to bring inflation back to 2%. Two things must occur to engineer the Fed’s outcome: (1) slow down the economy and (2) drive higher unemployment. Yes, monetary policy does not directly impact employment, as stated in the podcast. However, it is also clear that higher rates will slow down the economy sooner or later, leading to higher unemployment. Due to various structural reasons (low immigration, retirement, mismatched skills, etc.), the current low unemployment rate is more brutal to crack initially. To do so, we expect more rate hikes than the market wants or hopes to impact the economy negatively.

So, the real question is about the Fed’s resolve to bring inflation back to 2%. After all, it is not just about inflation; the Fed is mindful of inflation expectations becoming anchored. To support a strong anchor, the Fed must maintain its credibility. More rate hikes seem logical with a much-delayed pivot.

For the short term, it appears there is “no landing,” meaning we are cruising nicely forward with headline inflation coming down (base effect and waning COVID effect). In the medium term, we will switch back to a soft landing as we witness the impact of the long and variable lag from last year’s rate hikes (and as consumers spend down their COVID savings, getting out of their COVID-revenge spending and changing their sentiment about the future). With the Fed’s more dogged rate hikes this year, a hard landing (i.e., contraction) will ultimately ensue. By the way, a hard landing does not have to mean an economic crash, but a bumpy landing (a short and shallow economic contraction) is more likely.