The path to a soft landing.
The term soft landing has been used frequently in recent news articles mostly when describing the desired outcome of central bank policies. But what does it mean to investors?
Within multi-asset investing, a “soft landing” is a term used to describe the situation where an economy or a financial market undergoes a controlled and gradual slowdown rather than a sudden and severe downturn. It is essentially a scenario where economic growth or market conditions moderate without causing a recession, financial crisis, or significant negative impact on various financial assets.
Achieving a soft landing is a delicate balancing act for policymakers, as it involves making timely and well calculated decisions to moderate economic growth or market exuberance without inadvertently causing a downturn. Overly aggressive measures can lead to unintended consequences, such as a recession, while a failure to act can result in overheating and financial instability. Clearly, the failure of central banks to react to rising inflation in 2021 has borne the consequences today of much higher interest rates and more prolonged price pressures.
Perhaps the misunderstanding in this part of the economic cycle has been about the supposed path to a soft landing. The US economy dominates that of the western world – ‘when the US sneezes the rest of the world catches a cold’. Up until quite recently markets in the US had priced in several rate cuts over the next nine months as being the necessary medicine for a soft landing. However, US economic output currently appears too strong to justify this: whilst job growth has slowed substantially, it has continued to exceed the expectations of policymakers; measures of consumer demand remain robust, and inflation remains above 2%.
This is where those “key characteristics” of a soft landing (see below) become useful when framing the current economic backdrop: There is little evidence of a rapid economic slowdown in the US; markets are resilient (although volatile, currently); inflation is falling but not yet at target levels; employment growth continues, and forward guidance indicates higher GDP growth and lower unemployment ahead. Rather than interest rates needing to be reduced, in line with previous market expectations, an unusual adjustment is ongoing – markets are acknowledging stronger US economic fundamentals by pricing slower interest rate cuts in the future.
The concept of a soft landing underscores the importance of prudent economic and financial management, forward-thinking policy, and effective communication in navigating the complexities of economic cycles and market dynamics. When executed successfully, a soft landing can help sustain economic stability, promote long-term growth, and protect the interests of investors, businesses, and the general population. However, such growth outcomes can only be viewed in the ‘rear view mirror’. We remain faithful that policy makers will avoid the failures of the past and act with prudence when reducing economic excesses, whilst maintaining aggregate employment levels. Multi-asset portfolios stand to benefit from this desired outcome.
Key characteristics of soft landing include:
Gradual Economic Slowdown: In the context of an economy, a soft landing implies that the rate of economic growth is intentionally slowed down to a more sustainable pace. This is typically done to prevent the economy from overheating, which can lead to inflation, asset bubbles and other imbalances. Measures such as interest rate hikes, reduced government spending, or changes in monetary and fiscal policy are often used to achieve this gradual deceleration.
Market Stability: In financial markets, a soft landing suggests that asset prices, such as stocks and real estate, adjust in a controlled manner rather than experiencing a sudden and sharp decline. This controlled adjustment helps prevent severe market dips and panic selling.
Inflation Control: One of the key goals of achieving a soft landing is to manage inflation. By slowing down economic growth, policymakers aim to curb inflationary pressures, ensuring that prices remain stable or rise at a moderate and manageable rate.
Employment Preservation: Soft landings also aim to protect employment levels. During an economic slowdown, maintaining job stability is a priority, as a sudden downturn can lead to widespread layoffs and increased unemployment. A controlled economic adjustment helps avoid these negative consequences.
Forward Guidance: Central banks and financial authorities often use forward guidance to signal their intentions to the market and the public. Clear and transparent communication about policy actions helps manage expectations and reduce uncertainty.