It may seem like the economy is improving, but it could be the calm before the storm that leads to a possible recession.
According to the well-known economist Gary Shilling it is still too early to celebrate a soft landing. In fact, there are several economic signs that point to the fact that the United States may still be headed for a recession. As an economist, Shilling is known for a track record of accurate predictions dating back to the 1960s, including the 2008 housing crash.
This time, despite the unusual economic environment in which the Fed was able to tame inflation without causing a rise in the unemployment rate, Shilling says that the very American tendency to believe in a rosy future overshadows some clear signals of alarm. “A lot of people hope it’s a soft landing, but we Americans tend to be perennial optimists,” Shilling said during an interview on Supporters of the retirement lifestyle broadcast.
Shilling did not foresee a recession. He did, however, point to the current trajectory of the labor market and the fact that interest rate increases historically lead to recessions as evidence that one was likely.
Not even a soft landing has happened yet, Shilling points out. For a soft landing to occur, the Fed would have to raise interest rates and successfully lower them without pushing the United States into a recession. The only time this happened was in the 1990s. So far, he says, rates have risen nearly a dozen times since the Fed started raising them in March 2022. But the Fed hasn’t started lowering them, meaning the process that would lead to a soft landing is still incomplete .
“It’s only when they actually go from a tight situation to a relaxed situation that you can say they’ve had a soft landing,” Shilling said.
The economy is still waiting for rate hikes to take effect
Especially interest rate increases can be a reliable indicator of a possible recession, says Shilling. He is not alone in this theory. Many economists have recently pointed out that on average it takes just over two years – about 26 months – from when the Federal Reserve starts raising interest rates for the country to fall into a recession. “Well, it’s been 24 months since they started raising rates,” Shilling said.
Top Wall Street economists at banks like Morgan Stanley and Piper Sandler echoed Shilling’s view. Morgan Stanley’s chief US economist said a hard landing was a “guarantee”. Nancy Lazar, chief economist at Piper Sandler, also warned that the country is just heading into a period where a recession could be expected. All these calls for a wait-and-see approach are in line with famed economist Milton Friedman’s concept of the “long variable lag” that the effects of monetary policy decisions often require extended periods of time to manifest in the economy.
Meanwhile, what dampened the spirits of those hoping for a soft landing was the fact that Fed Chairman Jerome Powell postponed talks on interest rate cuts. This would have signaled to the public that the Fed considers inflation to be under control. Only a few analysts thought Powell could do it as early as March. When Powell rejected the idea, their confidence was shaken. “Boy, this has caused a momentary setback in optimistic views,” Shilling said.
Many of the firms that had forecast a rate cut in March, such as Goldman Sachs, revised their forecasts last month. Even if the Fed does not lower rates in March, it still expects three cuts during the year. However, Powell made it clear that before doing so he is waiting for signs that inflation remains low. “We want to see more evidence that inflation is moving sustainably to 2%,” Powell said 60 minutes in February.
Shilling was not surprised by the Fed’s delay. “The Fed will take all the time it needs to cut rates,” he said. “They want to make sure inflation gets back to their 2% target.”
A labor market that is easing, but still tense
Closely linked to inflation is the unemployment rate. Conventional wisdom has always held that to lower inflation you need to raise the unemployment rate. Inflation has so far fallen from 2022 highs to a much more manageable 3.1% in January, without leading to spikes in unemployment.
Currently the job market is still strong, although not as buoyant as it was at the height of the Great Resignations. Instead, workers are choosing to stay longer than they have in recent years, when they felt they could get a new job with better wages with relative ease. Shilling believes the job market will have to soften before the Fed begins lowering rates, which will also be when the country will know definitively whether the economy will maintain the soft landing.
At one point in January 2023, a staggering 96% of people said they were looking for a job during the year, according to a survey by the jobs website Monster.com. However this trend has started to reverse, or at least revert to the mean, with job changers no longer earning the almost guaranteed 8.5% pay increases achieved in 2022.
In the meantime, however, according to Shilling, companies are also causing tension on the labor market. In his view, many companies are reluctant to let people go after fighting so hard to hire them in a historically competitive job market.
Because “there used to be so much tightness in the job markets, all the hiring has created a mentality where companies don’t want to turn around and fire people even if their sales and profits are weak,” Shilling said. “It takes time to shift gears 180 degrees, especially after they have had to go through so much pain, expense and difficulty hiring people. So this lengthens it.
All this uncertainty, both in the job market and across the economy, means consumers are slowly cutting back on spending. This, too, indicates a reversal of a long-standing trend that had puzzled economists. The American consumer, whose spending represents approximately 70% of the US economy, has proven extremely resilient. Now that, too, is starting to change, Shilling notes, which portends changes in the American economy as well. “If consumers move from exuberance to caution, the payoff is huge [impact on] the total economy,” says Shilling.