As US recession fears ebb, hopes remain high for Fed’s promise of soft landing

WALL Street economists are tipping their hats to US Federal Reserve chairman Jerome Powell and starting to believe in the central bank leader’s promise of a “soft landing”.

Just two months ago, Wall Street oddsmakers did not think much of Powell’s goal, with a unanimous forecast for a 2023 recession caused by the Fed’s radical series of interest rate hikes.

Even Powell himself began to talk about the central bank’s effort to win a war on two fronts – fighting inflation and recession risks. The funeral march that sounded was like Goldilocks’ bowl of porridge: nobody knew for sure how the US economy would fare, but it was either going to be too hot or too cold.

A new picture emerged after fresh economic data in June and July came in, and it was enough to put the three bears off their porridge. Jobs growth, consumer spending, inflation, earnings, even factory activity – they are all at a temperature consistent with economic expansion, but cool enough for the Fed to cease rate hikes.

Last week, economists at brokerage Bank of America Global Research cancelled their forecasts for a recession in the US. Goldman Sachs, meanwhile, has steadily reduced the odds of a recession in the world’s largest economy.

Even Michael Wilson, the Morgan Stanley strategist who looked upon the euphoric 2021 post-pandemic economic universe and spotted the 2022 comedown that eluded every other prognosticator – recanted his bearish views on the 2023 stock market.

“It seems like more people are jumping on the soft-landing bandwagon,” said JD Joyce, president of financial advisory Joyce Wealth Management in Texas. “It looks like the Fed is accomplishing what they have been attempting to do since last March, and that’s to slow down the economy without wrecking it.”

The second-quarter earnings season was far less severe of a slowdown than analysts had predicted, Joyce pointed out. 

It was a “solid beat-and-raise quarter”, said Savita Subramanian, equity strategist at Bank of America Global Research.

Currently, the average analyst target for Q3 S&P 500 profits indicates that the “earnings recession” will end after three straight quarters of aggregate profit contraction for companies tracked by the broad index. Skirting a recession may seem like a technical victory for the Fed rather than a substantive one, but the difference between shrinking and growing earnings makes all the difference for a stock.

That is why Apple has tumbled 10 per cent since logging another drop in its revenue on Aug 3, while Amazon jumped about 10 per cent after reporting profit growth the same day.

For this reason, the S&P 500 may have a 10 per cent “upside” if the US stays out of recession this year, strategists at brokerage Deutsche Bank told Bloomberg.

A soft landing is still seen as a significant slowdown. China’s economy has not yet emerged from its pandemic slump. American banks remain on shaky footing, with recent downgrades from Moody’s noting the sector’s vast exposure to half-empty office buildings in large US cities such as New York and San Francisco.

The same forces that drove up inflation in 2022 – the marauding Russian army and its impact on the price of oil and commodities – are still at large and driving up the prices of energy and grains again.

“The recession fears are ebbing,” said Joel Prakken, co-head of US economics at research firm S&P Global Market Intelligence, in a note to clients. “Nevertheless, we expect a period of below-trend growth – with a rise in the unemployment rate to 4.5 per cent to 5 per cent – will be required to bring inflation down to 2 per cent within a time frame acceptable to the Fed.”

For the bulls, however, that sounds like overthinking it. There are reasons why it is called an economic cycle. If the US economy is not contracting, it is usually accelerating. If the 2022 stock market rout foreshadowed the slowdown in earnings during the last three quarters, the recent surge could foreshadow an economic rebound.

This is consistent with recent comments from major corporations such as General Electric and Intercontinental Hotels, which see an ongoing boom in travel driving demand for jet engines and hotel rooms; and from packaging companies such as Westlake, who say that retailers have finished selling down inventories that were overloaded during the optimistic early post-pandemic days.

The bulls believe that the inflation and recession scares have passed. Many firmly believe that Powell will now hang up his rate-hike spurs, and allow homebuyers, tech investors and US consumers to get back to what they do best: spending. If they are right and the soft landing is a fait accompli, the S&P 500 is likely to reach an all-time high in the coming months.