Is A Soft Landing Still Possible?

The Fed's sole focus is to bring down inflation right now. Throwing the economy into a recession is something they're more than okay with; the best case, however, is if they can somehow engineer a soft landing instead.

So what exactly is a soft landing and is it even possible at this point?

When people refer to a soft landing, they're referring to a gradual economic slowdown that brings inflation down without triggering a recession.

The current data looks pretty good, but looks can be deceiving. After all, Jerome Powell himself said that the window for a soft landing "has narrowed" at his press conference earlier this month.

Let's take a look at some of the data from this week first, before diving into the simple reason why I think a soft landing is pretty much impossible.

GDP Growth is Up

We saw a modest growth in real GDP in Q3 of this year, rebounding off of two negative quarters of GDP growth in Q1 and Q2. As you can see from the image at the top, the Atlanta fed now estimates that we'll observe a 4.2% growth in real GDP in Q4.

This is up from the annualized growth of 2.6% in real GDP that we observed in Q3.

This seems to be a great trend right? We had CPI come down last week, but GDP looks like it's going to grow even more than it did last quarter.

This is just an estimate for now; depending on how the holiday season goes, I'm sure we can see some revisions to the number between now and the end of the year. The point is, however, that if it's directionally correct, we're seeing a trend of rising GDP growth this quarter.

Contributors to Inflation are Going Down

Now let's take a look at some of the inflation related statistics to see if we can figure out where inflation is going.

One fantastic chart I found this week was the Freightos Global Container Freight Index:

As we can see, shipping prices have fallen tremendously from the peak in the middle of the pandemic.

The chart on the left shows the exact YoY comparison. If the trend continues, this will definitely alleviate some pressure on CPI moving forwards.

While this looks great on a surface level, we also need to be cognizant of how much this will impact CPI. I included a full breakdown of CPI in my previous newsletter, but the main conclusion there was that the bulk of CPI growth was shelter inflation and transportation, neither of which will be affected by this.

The categories that will be most affected by this (apparel and household goods) are actually already negative as of last month. While they can always be more negative, I think the bulk of the CPI reduction needs to come from the shelter component.

Another fun metric I found this week is the U.S. Baker Hughes Oil Rig Count:

We can see that the number of active oil rigs dropped steeply when the pandemic started, and have been slowly recovering. We're still a bit below pre-pandemic levels (we were at roughly 683 active oil rigs), but we're moving in a positive direction.

As long as OPEC doesn't engage in any funny business, the trend in this chart shows that we should continue to have downward pressure on energy prices. Cheaper oil is also good for inflation at large since it's an input cost into basically every single good in the economy.

Sounds Like a Soft Landing is Imminent right?

While I do think that it's theoretically possible for a soft landing, I think the probability that it actually happens is in the single digits.

There's a very simple reason that I think this, independent of the Fed's actions or skill.

Here's the bottom line: the Fed has hiked rates at its fastest rate in 40 years.

We simply haven't had enough time to observe the full effects of the rate hikes that we've already had.

It's widely understood that the effects of tightening take quarters (or even years) to fully play out.

For a deeper look and breakdown, I highly recommend reading through this wsj article.

A simple example of the impacts of rate hikes that haven't fully made their way into the broader economy can be found in the real estate industry.

As rates rose, housing transactions collapsed. Existing home sales were down 28.4% YoY in October. I also have no doubt that the number will continue to decline.

A bunch of different vendors get paid in each transaction, including real estate agents, title companies, insurance companies, etc. For each transaction that doesn't happen, a dozen people don't get paid.

We've started to see inklings of the pain to come in the form of Redfin layoffs and decreasing building starts for single family houses, but it's clear that the 30% decrease in transactions hasn't fully played out yet.

This, of course, is only one sector of the economy (albeit probably the most interest rate sensitive sector). Imagine similar things playing out in different industries.

I could also make the argument that something similar is happening in tech (to a much lesser extent). Tech stocks are very sensitive to interest rates since they're priced on high growth far into the future. With tech stocks down, tech companies have more pressure from shareholders to cut costs (headcount, capex, office space) to make the companies more lean and profitable.

Given this information, who among the readers has confidence that the Fed will be able to time right when the pain is about to be too much and immediately reverses their rate hikes enough to make sure the economy doesn't go into a recession?

While it's theoretically possible, I think we should give up on the idea of a soft landing.