The Economy May Not Actually Crash. Why "No Landing" Might Still Be Problematic.

The argument between hard landings and gentle landings has a new contender: no landing at all. Just don't hope for positive stock market news.

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Recent headlines have remained preoccupied with the question of whether the Federal Reserve will be able to smooth the economy's downturn as it works to control inflation or whether it will have to orchestrate a recession to get the consumer price index's growth rate back to its 2% objective. However, there is a third choice, where it never touches the earth at all.

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The economy maintains its upward trajectory in this "no-landing" scenario, but inflation is uncontrollable. And it's one that seems more and more likely. The phrase "strong" seems overstated after the release of January's payroll figures, but indicators of strength in the services sector are still stable. Even the manufacturing and housing data, which previously appeared to be locked in a downward cycle, are showing signs of life. The combination of lower price hikes and a strong economy has helped the S&P 500SPX -0.14% in 2023 rise. Inflation has even been moderating.

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Chris Zaccarelli, a chief investment officer of Independent Advisor Alliance, observes that "markets have been rallying this year as hopes of a gentle (or no) landing have been building, notably because inflation continues to fall back down, despite the labor market's resiliency."

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In a situation when Americans can find work in a booming economy and the cost of living is gradually declining from its highs, what is there to dislike? Plenty. This is because having more jobs allows Americans to continue spending, as shown by the most recent retail sales numbers, which increased significantly in January. In turn, this will keep prices high and on the rise at a time when inflation is much above the Fed's 2% objective and not declining as quickly as the central bank would like, compelling it to keep raising rates. Inflation is still decreasing but at a slower rate.

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Or, to put it succinctly in the words of BofA Global Research Investment Strategist Michael Hartnett, "No landing equals no Fed stopping."

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In fact, while "pivot" was the prior catchphrase of bulls, it is now appearing increasingly incongruous in a situation where the Fed has little motivation to halt, much less reverse, its program of interest rate hikes. Now, Deutsche Bank anticipates U.S. Rates set by the Federal Reserve will peak at 5.6%, up from their earlier prediction of 5.1%. Not far behind are money market futures, which predict a terminal rate of 5.3%, a sharp increase from the 4.8% that prevailed at the beginning of the month.

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Even more upbeat economists are beginning to express concern over the potential that increasing prices will continue to be sticky. The risks still exist, according to Ed Yardeni, chief investment strategist at Yardeni Research, who continues to predict a gentle landing and a robust stock market. In his article, he states that "Fed officials probably would conclude that the only option to get inflation down is through inducing a recession." Therefore, the inflationary no-landing scenario could end up being the difficult route to a harsh landing.

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You don't need to go back very far to see how the story turns out. Concerns over an ever-rising terminal Fed funds rate at the price of economic growth led to last year's bear market. According to Tom Essaye, the creator of Sevens Report Research, "a no landing would not be a permanent positive because it simply...delays, but does not eliminate, the hard vs. soft landing issue," The Fed will continue raising rates until it is certain that growth is slowing and that doing so won't push inflation higher.

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Keep in mind that you cannot battle the Fed.