United States – recession or soft landing?

In a nutshell

• In the face of slowing US growth, global trade tensions and muted inflation, the Fed has decided to pause its normalisation process – with no further rate hikes now expected this year.
• This surprisingly dovish Fed guidance caused some segments of the yield curve to invert, in turn prompting recession fears.
• For now, though, strong consumer tailwinds point rather to a soft-landing scenario.

The Fed’s March decisions were more dovish than expected, with guidance of essentially unchanged rates going forward (the famed “dot plot” – see chart 4) and an earlier-than-expected ending of the balance sheet normalisation process, now due to slow down in May and wrap-up in October.

While this does not necessarily mark the end of the tightening cycle, the Fed has effectively, in the face of decelerating domestic growth, global trade risks and muted inflation, decided to remain patient for an extended period. Our base case is now one of no hikes in 2019.

Financial conditions eased upon this dovish Fed guidance, leading some segments of the yield curve to invert for the first time since 2007 (see chart 5) – and hence prompting recession concerns. While we do take the yield curve signal seriously, we also note that it still requires confirmation, both along the maturity spectrum and in terms of other economic indicators (particularly since the Fed may never reach restrictive territory), and that there has historically been a time lag between inversion and a US recession (ranging from nine months to two years). We thus continue to believe that this economic cycle has legs, even if it is getting quite aged.

We would notably point out the strength of the employment / consumer landscape. Accounting for 70% of US GDP, US consumption currently enjoys far too many tailwinds (full employment, growing wages, low oil prices, available credit) to imagine that recession lurks just around the corner. Also, the drop in mortgage interest rates will boost residential investment, lifting home sales and construction.

Ultimately, a near-zero real Fed rate argues for a soft landing rather than a recession scenario. Until (or unless) the Fed finds itself forced to revert back to monetary normalisation, owing to employment/wage developments or perhaps to excessive leverage in the public and corporate sectors, the US economy should continue to grow at a pace close to its average for this cycle.