By Alexandra Semenova
The U.S. economy continues to outperform expectations. January saw half a million jobs added to the labor market and retail sales grow a whopping 3%.
And suddenly, strong growth and persistent inflation have investors contemplating a new course for the economy in the coming year — a "no landing" scenario.
As the Federal Reserve aggressively raised interest rates in 2022, investors debated whether these moves would result in a "hard" or "soft" landing.
Essentially, whether rapidly rising rates would quickly choke off economic growth and inflation, or gradually slow growth and price increases. In other words, would the Fed cause a recession, or just an economic slowdown?
The newly-coined "no landing" outcome instead considers a scenario in which inflation doesn't actually cool while economic growth continues, even as interest rates remain elevated amid the Federal Reserve's attempts to tamp prices down.
In the view of Apollo Global Management's chief economist, Torsten Sløk, there are growing signs of the market pricing in this outcome.
"In other words, the market is saying that inflation will be significantly higher in a year’s time than the Fed’s 2% inflation target," Sløk said in a recent note. "Put differently, instead of expecting a recession and lower inflation, short-term inflation expectations are rising and becoming unanchored."
Sløk highlighted the recent pick-up in one-year inflation breakevens, which are approaching 3% after the aforementioned run of strong economic data in January, suggesting investors are coming around to the idea of inflation remaining higher for longer.
One-year breakeven inflation expectations are rising and approaching 3%, driven higher by the strong January employment report and yesterday’s CPI report. (Source: Torsten Slok, Apollo)
But according to at least one economist, this narrative investors appear to be betting on is "nonsensical."
"Because we're in this highly volatile environment, and because there is so much uncertainty, we've now seen a number of different ways to interpret or call what we're seeing in the economy,” EY Parthenon chief economist Gregory Daco said in an interview.
A landing — however it may ultimately look — is going to happen eventually, in Daco's view.
The economy operates in a cyclical pattern, growing until it reaches its peak and then contracting before hitting a trough and rebounding again into an expansion phase.
"No landing does not make any sense, because it essentially means the economy continues to expand, and it's part of an ongoing business cycle and it's not an event — it's just ongoing growth," he added. "Doesn’t that entail that the Fed will have to raise rates more, and doesn’t that increase the risk of a hard landing?"
Federal Reserve Chair Jerome Powell speaks at The Economic Club of Washington, D.C., U.S, February 7, 2023. REUTERS/Amanda Andrade-Rhoades
Sløk also indicated the no landing scenario would be likely to bring back the volatile market action we saw in 2022 because it reintroduces uncertainty about inflation and the Federal Reserve.
But the Federal Reserve hasn't exactly given reason for uncertainty: officials have consistently asserted for months that rates are likely to rise above 5%.
Federal Reserve Powell has said as much himself: "There has been an expectation that [inflation] will go away quickly and painlessly; I don’t think it’s guaranteed that's the base case," he cautioned last Monday at the Economic Club of D.C. "It will take some time."
And Sløk's own expectations for how the Federal Reserve will handle this scenario align more with Daco's thinking than current market pricing.
"The Fed will have to be more hawkish to ensure that inflation expectations do not drift too far away from the FOMC’s 2% inflation target," Slok said in a note.
Which suggests officials may in fact need to raise rates higher, increasing the risk of a "hard landing" in the end.
What to Watch Today
Economy
- 8:30 a.m. ET: Import Price Index, month-over-month, January (-0.1% expected, 0.4% during prior month)
- 8:30 a.m. ET: Import Price Index excluding petroleum, month-over-month, January (-0.3% expected, 0.8% during prior month)
- 8:30 a.m. ET: Import Price Index, year-over-year, January (1.4% expected, 3.5% during prior month)
- 8:30 a.m. ET: Export Price Index, month-over-month, January (-0.2% expected, -2.6% during prior month)
- 8:30 a.m. ET: Export Price Index, year-over-year, January (2.8% expected, 5.0% during prior month)
- 10:00 a.m. ET: Leading Index, January (-0.3% expected, -0.8% during prior month)
Earnings
- AMC Networks (AMCX), AutoNation (AN), Barnes Group (B), Deere (DE)
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