Will the world’s largest economy, the US, finally achieve a soft landing after the recent interest rate hikes?
The US unemployment rate, known for its mean reversion characteristics, poses a challenge for a soft landing. Typically, low unemployment rates will eventually reverse, complicating efforts to maintain stable employment levels. The kinked Phillips curve framework indicates that very low unemployment makes inflation highly sensitive to economic slack, necessitating precise monetary policy from central banks to avoid overheating or excessive cooling of the economy. See Figure 1.
Figure 1
For the past two and a half years, the US unemployment rate has stayed below 4%, with consistent payroll growth of 242 000 over the last three and six months. However, the gap between job openings and unemployed workers, has diminished significantly, raising concerns that unemployment could rise rapidly if this trend continues. Alternative data sources like Indeed and LinkUp corroborate this decline in job openings, reflecting a cooling labour market.
Despite the widespread predictions of an imminent recession in 2022, the absence of significant imbalances in housing and manufacturing sectors delayed such an outcome. The homeowner vacancy rate remains near historic lows, suggesting stability in single-family residential construction despite high mortgage rates. However, certain regional markets in the US, like Texas and Florida are seeing rising inventories and falling rents, indicating potential oversupply.
Multifamily construction is also on a decline, with the national vacancy index rising significantly since October 2021. This trend points to a prolonged weakness in the sector. In manufacturing, the ISM new orders index follows a three-year cycle of weakening and strengthening. After peaking in June 2021, it bottomed out in January 2023 but has struggled to maintain recovery, hinting at structural challenges or lingering effects of pandemic-related disruptions.
Consumer discretionary spending faces headwinds from a low personal savings rate, which has fallen to levels last seen during the pre-GFC housing bubble. Unlike then, homeowners are now less reliant on home equity lines of credit, instead drawing on pandemic savings and credit card borrowing, both of which are showing signs of exhaustion. A gradual increase in the savings rate is needed to sustain spending without triggering a disorderly adjustment.
There was widespread concern regarding the health of financial markets following the collapse of Silicon Valley Bank. The collapse highlighted vulnerabilities, especially among regional banks heavily exposed to commercial real estate. Despite stabilised fears, mark-to-market losses on bank balance sheets remain significant, with rising delinquency rates on office loans signalling ongoing stress. Lending standards have tightened, forecasting a slowdown in bank lending and overall loan growth.
Credit conditions also reflect this tightening, with the 6-month bank credit impulse suggesting a likely decline in bond yields. The speculative-grade debt default rate has increased, though a recent thawing in capital markets may temper further rises. However, credit card and auto loan delinquencies are climbing, reaching levels not seen since 2012, necessitating stabilization in lending standards and delinquency rates to support a soft landing.
US inflation reaccelerated in early 2024, driven partly by faulty seasonal adjustments which overstated certain aspects of the CPI basket. However, the April CPI data hinted at deceleration. Excluding pandemic-affected categories, such as shelter and healthcare, year-over-year CPI inflation has stayed below 2% for the past 12 months. Wage growth moderation, due to a cooling labour market, has further dampened inflationary pressures.
Despite cooling inflation, the Fed remains cautious as long-term inflation expectations hover near post-GFC highs. Any new inflation surge could destabilize these expectations, complicating the Fed’s decision for interest rate cuts and potentially jeopardizing the soft landing.
Global economic convergence has reduced growth disparities between the US and other major economies since April 2024. This alignment has narrowed interest-rate differentials (shown in figure 2), coupled with improved growth in Europe, driven by stable manufacturing, lower energy costs, and rising real wages, along with stronger Chinese exports, has placed significant pressure on the US dollar.
Figure 2
To reinforce global soft-landing prospects, more substantial stimulus from Chinese authorities is needed, as current measures are insufficient to meet developers’ financing needs. Overall, achieving a soft landing across various sectors requires careful calibration of monetary policies, stabilization in key economic indicators, and addressing structural challenges within the global economy.
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