Many market participants are now anticipating a recession by 2020 or 2021. This narrative is reflected in
the signal from the flattening yield curve and inversion in some forward measures of market expectations
for the fed funds rate. It is also supported by historical experience. Indeed, the Fed has never been
able to achieve a soft landing from below, that is, return unemployment back up to its natural rate
without causing a recession. While we expect growth to slow in 2020, at the risk of declaring that “this
time is different”, we think the Powell Fed has a reasonable shot at making history by achieving a soft
landing. This piece lays out our case.The Fed has several things going for it. A major one is the absence
of a significant overhang of investment in durables and structures and related financial imbalances,
which have usually triggered or amplified downturns in the past. Next are a relatively flat Phillips
curve and favorable supply-side trends that could diminish inflation risks and allow the Fed to move more
cautiously. Reduced US sensitivity to potential oil market shocks also helps.The most obvious risk to the
soft landing scenario is that overheating causes the Fed to tighten more aggressively which tips the
economy into a recession. However, there is also the risk that productivity could surprise significantly
to the upside, allowing both the labor market to equilibrate smoothly and the economy to expand at a more
elevated pace for some time to come.For the Fed, the issue of how this cycle may end becomes increasingly
important ahead of next week’s FOMC meeting when it extends its projections to 2021. Consequently, the
Fed must ponder what signal to give the market about its intentions to begin eventually to return the
labor market toward more sustainable levels.
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