The case for a soft landing

This is an audio transcript of the Unhedged podcast episode: ‘The case for a soft landing’

Ethan Wu
In the past 18 months, we’ve had this very fun debate in financial markets. Is the economic landing going to be hard or is it gonna be soft? And, you know, this matters, right? When you have high inflation and high growth, the central bank, the Federal Reserve, they raise interest rates, [MUSIC PLAYING] brings down both inflation and growth. But which one does it bring down first? Do we get inflation back to that 2 per cent target without a catastrophic crash in growth? Or does that crash in growth come first and then bring the inflation down? It really matters which way it goes. And it looks more and more like we’re heading toward the better version of that, the soft landing, inflation coming down gently without growth crashing to the other. Today on the show we discuss three indicators for a soft landing and just one against. This is Unhedged, the markets and finance show from the Financial Times and Pushkin. I am reporter Ethan Wu here in the New York studio, joined as ever on Tuesdays by hard landing expert Katie Martin, who, as I understand, has been falling off walls, bikes, buses, trains, all forms of transportation.

Katie Martin
People seem to find it very funny when bad things happen to me. (Ethan laughs) There was a time I cycled into a canal . . . 

Ethan Wu
Oh, God.

Katie Martin
 . . . that people thought was hilarious and I did not. That’s for a whole other episode. Landings, yes. I fell off a climbing wall in January. That hurt quite a lot cause I broke my ankle.

Ethan Wu
Ooof.

Katie Martin
And then a few weeks ago, I was distracted by a really nice dog while I was running and I fell over and hurt my knee. So I know about landings, yeah.

Ethan Wu
These are all stories in which I think you look good, though, because on the one hand you’re doing the trendy sport that is rock climbing. (Katie laughs) On the other, you’re looking at a cute dog, which, I mean, that makes you, you know, really the victim in that story.

Katie Martin
I just need to fall over less, (Ethan laughs) I think, generally.

Ethan Wu
Today, though, Katie, we are not talking about your hard landings. We’re talking about the US economy’s soft landing, which looks more and more like it could be coming. And today we got three indicators to suggest that it may indeed be coming. And just one reason for a little bit of caution.

Katie, I think we have to start with inflation, right? Landings are sort of all about inflation. Usually what happens in a cycle is the economy gets overheated, inflation’s running hot and growth’s running hot so the central bank needs to raise interest rates to lower demand. That has a tendency of bringing down both inflation and growth. And the question is, do you get inflation back to a target, something like 2 per cent, without a really devastating downturn in growth? And, you know, I think the most important point of progress there is where’s inflation? Because that’s ultimately what you’re trying to achieve if you’re the central bank and man, it’s fallen quite a bit. Like, people will have heard the headline number in the US.

Katie Martin
Yeah.

Ethan Wu
Three per cent. A lot of that reflects energy prices, which have come down in quite a big way. But I think one interesting way of looking at it, Katie, is you look at the median CPI component, right, The CPI, the consumer price index, it’s all these different prices. What’s the very middle one, right? The middle CPI component was 7.9 per cent in February. More recently in June, it’s come down from 7.9 per cent to 4.4 per cent, which is not 2 per cent. But that’s a lot of progress.

Katie Martin
Yeah, it doesn’t matter where you are on the kind of long-running argument about whether the Fed is going to nuke the economy. You cannot get around these inflation numbers. You know, somehow they’ve actually managed to pull this off. They’ve managed to get inflation much, much closer to target, pull it right down. We can argue about whether that was really them or whether it was something else. But anyway, the point is inflation has come right back down, just as the Fed has finished with, like, more than five percentage points of interest rate rises. It might have one more to come, but let’s see about that. This has all managed to happen without crashing the economy. And the Chicago Fed president Austan Goolsbee put it quite nicely the other day. He was saying the job for the Fed is to stay on the golden path (Ethan laughs) where inflation comes down without causing a recession. And we’re on the golden path, Ethan. Learn to love golden path.

Ethan Wu
Austan Goolsbee’s been getting into Buddhism recently. He’s learning about the eightfold path of the economy, (Katie laughs) the noble truths that will bring us to soft landing.

Katie Martin
(Laughter) So what’s interesting to me is that, well, lots of interesting bits here, but one interesting bit here is that the investment community, like the universe of investors that are out there, whether they’re institutional or retail or whatever they are, have also learnt to love the golden path. They, you know, for months, ever since October, actually stocks have been pushing higher, risky assets have been pushing higher in price. And there’s been a large number of people who’ve been saying this is a bear market rally. Don’t believe it. Don’t believe it. Well, you know, 28 per cent later on the S&P 500 since October, it really feels like a point where there’s a big capitulation going on and people are absolutely throwing in the towel on that bearish view. And there’s something in the air and in markets now where the mood is really turning.

Ethan Wu
And we’ll get to the market reaction a bit more in a second. A little sneak preview for the listener. But I wanna move to the second indicator, which is, you know, which is GDP, which is growth.

Katie Martin
Yeah.

Ethan Wu
Which in inflation-adjusted terms in the second quarter came in at 2.5 per cent annualised. That’s not a roaring economy by any means, but it’s a perfectly healthy one, you know, And it’s also no longer just the consumer. In the second quarter, we got a one percentage point boost from capital expenditure. So companies are investing too. That’s me. You know, it’s really quite honestly, quite surprising that you’re getting a capex number that strong with interest rates at 5 per cent. But it seems people are spending, companies see how healthy consumer spending is and they’re responding to that by investing in capacity. Listen, if people keep buying you gotta keep selling. And that’s keeping growth again, not booming, but perfectly healthy.

Katie Martin
Yeah, I think it’s really important to make a distinction, right? So the idea that we might achieve, and it looks like we are achieving a soft landing rather than a hard landing, ie a horrible, massive recession that involves lots of job losses. A soft landing does not mean rapid growth.

Ethan Wu
Right. Right. (Katie laughs) That’s a very good point.

Katie Martin
It still means that the economy is not like, you know, rah-rah, go, go, go. It still means that growth is like, OK, you know. Normally we would be so disappointed, but right now we’ll take it. So I don’t think you should run away with growth expectations. And if anything, if growth did explode higher, growth rates did explode, then we might have the opposite problem, which is that inflation would pick back up again and the Fed would have to get a big red pen marked “rate hike” back out the cupboard and start at it (Ethan laughs) all over again. And then we really are in trouble. So we don’t want that.

Ethan Wu
No, that’s exactly right. I think the path to a soft landing has to involve . . . 

Katie Martin
The golden one. Don’t forget the . . . 

Ethan Wu
Excuse me, yeah. Sorry, the eightfold Bloom path to a soft landing must require a period of below-trend growth, a period of subdued but not crashing growth. And is 2.4 subdued? Arguable. I don’t feel strongly either way. It probably needs to come in a little bit softer, but it’s at least in the ballpark.

Katie Martin
Hmm.

Ethan Wu
But yeah, that’s the path, right? It’s, consumption slows, growth slows, but not in a devastating way. Inflation comes down as both a result of, you know, all the supply chain issues we’ve had in the past couple of years starting to work their way out. And we’ve seen a lot of progress there, though I’ll say it’s not 100 per cent solved. And so you have better supply, a small tick down in demand and hey, there’s your soft landing.

Katie Martin
Yeah. And most importantly, you haven’t fried the jobs market.

Ethan Wu
Yes.

Katie Martin
You haven’t left loads of people out of work.

Ethan Wu
Yes. So I think this brings us to our third indicator for a soft landing, which is consumer confidence.

Katie Martin
Never, ever bet against the US consumer. (Laughter) This is the moral of the story.

Ethan Wu
No. And consumers have been absolutely relentless this cycle. But you know, the number here, it comes from the University of Michigan. They do this monthly consumer sentiment survey. It’s risen 39 per cent year over year and 11 per cent month over month through July. And I think the really remarkable thing is how depressed consumer sentiment was despite the fact that consumer spending has been so strong for so long.

Katie Martin
Yeah.

Ethan Wu
And there were periods in the past year or so when you had softness in business investment, softness in capital expenditure, softness in the housing market, softness in manufacturing. But there was one part of the economy, one leg that stayed sturdy.

Katie Martin
Yeah.

Ethan Wu
That was, as you said, Katie, the mighty US consumer. (Katie laughs) And that’s even when consumer sentiment was depressed. They didn’t give a crap. They just kept spending.

Katie Martin
Is there a statue anywhere to the mighty US consumer? (Both laugh) I feel like there probably should be.

Ethan Wu
It’s called the Apple Store.

Katie Martin
(Laughter) One thing that comes out of all this is that, you know, as we were saying, markets have been doing very well. There’s a little part of me — maybe it’s because I’m a slightly miserable Brit who keeps injuring herself (Both laugh) in stupid accidents — has previously discussed that makes me think, is this all a bit much? So we’ve just had five months of gains in the S&P 500, the longest rally, I guess, in those terms since the summer of 2021. July pumped out more than 3 per cent gains. And if you look at options markets where you go to protect yourself against horrible things happening, effectively the cost of insuring yourself against a big drop in the S&P 500 is tiny now.

Ethan Wu
Yeah.

Katie Martin
So the market is just like investors have got their fingers in their ears. La la la. Everything’s fine. You know, what war in Ukraine, what potential for a recession? You know, what chance that inflation comes roaring back? They’re just not taking out this insurance, if you like. So, you know, Bank of America was saying these are the cheapest puts you’re ever likely to have seen, so it’s the cheapest, you know, cost of insuring yourself against horrible things happening to your portfolio pretty much ever. And they’re saying use it, you know. Just take out that little bit of insurance just in case. And so there is a part of me that thinks, OK, everyone was super bearish going into this year. We’re now in August. It’s already August.

Ethan Wu
Oh, yes. Oh, God.

Katie Martin
That happened but we’re in August and everything is rosy and lovely and there’s this kind of yay, everything is awesome thing going on. And you just wonder whether everyone’s run from too far . . . 

Ethan Wu
Yeah.

Katie Martin
. . . on one side of the ship to too far on the other side of the ship.

Ethan Wu
That’s a great point. It’s worth remembering that just a couple months ago, I mean, we were talking about, is the debt ceiling going to cause a catastrophic panic? Is recession right around the corner? It’s just all this worry, worry, worry. And like you said, we’ve gone from fear to greed in, like, cut time.

Katie Martin
Yeah.

Ethan Wu
The market tends to get ahead of itself. That’s really like in some ways it’s a built-in property.

Katie Martin
That’s it’s job.

Ethan Wu
Yeah, exactly. The stock market is there to get ahead of itself. But, you know, a lot of bad news has been priced out, I think, you know, because recession calls were just everywhere and gloom was everywhere for so long, investors have forgot that there’s a such thing as a middle ground, (laughter) you know.

Katie Martin
Yes.

Ethan Wu
Where like, again, growth is going to come in fine in a soft landing. Not great, but fine. What does that mean for corporate profits? Corporate profits are going to be just OK. You’re not going to get a lot of amazing beats or fantastic guidance. You’re going to get profits that are fine, you know. And that might not be a recipe for stocks going up forever. It’s been widely noted that a lot of the rally in the last couple months in US stocks has come from what’s called multiple expansion, which is investors look at how much profit a company makes and they say this stock is worth 10 times earnings, 15 times earnings, 20 times earnings. And that multiple depends on the investor’s view of the company’s prospects far into the future. Those multiples, that kind of subjective estimate from investors has driven almost all of the stock gains we’ve seen so far as opposed to . . . 

Katie Martin
Yeah.

Ethan Wu
. . . actual organic growth and corporate profits. Profits are flat to down.

Katie Martin
The companies haven’t got better. It’s just that more people are willing to throw money at them.

Ethan Wu
Exactly. Exactly. And that gives some reason for caution at this juncture in the market. But I want to move, Katie, to just one more indicator, which at least from a macroeconomic perspective, why maybe it’s a little too early to be saying 100 per cent soft landing, and that’s the labour market, right? The labour market is still way out of balance. There’s still more demand for workers than there is supply for workers. And that’s a problem for the central bank. It’s a problem for the Federal Reserve because at the end of the day, if there are too few workers in the economy, that keeps the labour market tight, that keeps wage growth high, and the Fed thinks that shows up in inflation, specifically non-housing services inflation.

So, you know, one way that’s popular to measure the tightness of the labour market is this measure called the jobs/workers gap. And it shows the difference between how many jobs are out there that employers want to fill minus how many workers are there in the labour force to fill those jobs that need to be filled. So if you’ve got a big gap, that means there’s way more jobs than there are workers to fill those jobs. A smaller gap means that it’s a little more closer to balance. So Goldman Sachs has a nice measure of this. They put the gap at 3mn. That’s 3mn more jobs than there are workers versus the 2mn that Goldman thinks is consistent with 2 per cent inflation. So by Goldman’s reckoning, we’re still at least a million workers short of where we need to be to get that real proper soft landing scenario.

Katie Martin
Yeah, I mean, at the risk of kind of mumsplaining here, you know, if we don’t have enough workers, then effectively companies are gonna have to pay more to get more workers, and then you get more and more wage growth. Then that feeds into the rest of the kind of inflation puzzle, if you see what I mean. And then we’re back to square one. So not enough workers is not a good thing. Ethan, have you thought about working harder? Maybe you’re the problem.

Ethan Wu
I’ve been trying to work a million times harder. [MUSIC PLAYING] So it’s actually (overlapping talk)

Katie Martin
You do do several jobs, to be fair. (Both laugh) We get our money’s worth out of Ethan Wu here at the FT.

[MUSIC PLAYING]

Ethan Wu
This is true, this is true. I have at least two jobs as both podcaster and newsletter writer. But I have a third job and that has taken us to Long/Short. We’ll be back in a moment with my third job.

Welcome back. This is Long/Short, that part of the show where we go long a thing we love, short a thing we hate. Katie. I’m long robber barons. (Laughter)

Katie Martin
You are?

Ethan Wu
I was visiting a very nice estate in upstate New York over the weekend that was once owned by Jay Gould, the US railroad magnate, back in the Gilded Age.

Katie Martin
What a name. That’s superb.

Ethan Wu
Right? Jay Gould. Yeah, G-O-U-L-D. I didn’t know terribly much about this guy. I think I’d heard about him in history class, but I was reading into some of his, you know, business ventures back in the day, and he made a killing doing, like, speculative investments in railroad stock back when that was hot. And he had this, like, hilarious business war with Cornelius Vanderbilt, where Gould and some of his co-conspirators, like, bought into this company called Erie Railroad and issued fraudulent shares that were sold to Vanderbilt, (Katie laughs) like $7mn worth, which he, like, lost all of that money. And then the fight ends up in the New York state legislature, like over, you know, should the fraudulent stock be legalised or not. Gould shows up at the Albany State House with 500K in cash, just starts handing it out to representatives in the State House. Political corruption was just so much different back then and I love it. I think we should bring it back. It’s more honest, don’t you think?

Katie Martin
That does sound like it was better quality? Yeah, for sure.

Ethan Wu
It’s right there in the open. There’s no dark money. None of this stuff. It’s very plain. It’s light money, bright money.

Katie Martin
(Laughter) So I am short people who leave glass on the roads, putting punctures in my bike tires. (Ethan laughs) I’m extremely grumpy with all of them. A hex on all their houses. (Ethan laughs) That is it. On a related note, I’m about to go on a long holiday.

Ethan Wu
Ooh. Fun.

Katie Martin
So you won’t see me or hear from me for a little while. I’m sure you will look after the podcast without me, Ethan.

Ethan Wu
Please don’t have any hard landings while you’re on (Katie laughs) a long vacation. You might not come back from it. (Laughter)

[MUSIC PLAYING]

Katie Martin
(Laughter) OK, I promise I won’t.

Ethan Wu
We need to get you, like, some knee pads and, like, a really nice helmet so that all your landings are soft. That’s what I think.

Katie Martin
Knock it off. Just leave me to go on holiday.

Ethan Wu
All right Katie, please enjoy your time off. Listeners, we’ll be back sans Katie Martin on Thursday for another episode of The Unhedged podcast. Catch you then. Unhedged is produced by Jake Harper and edited by Bryant Urstadt. Our executive producer is Jacob Goldstein. We had additional help from Topher Forhecz. Cheryl Brumley is the FT’s global head of audio. Special thanks to Laura Clarke, Alastair Mackie and Jess Truglia. FT Premium subscribers can get the Unhedged newsletter for free; a 90-day free trial is available to everyone else. Just go to FT.com/unhedgedoffer. I’m Ethan Wu. Thanks for listening.

[MUSIC PLAYING]

Hey, listeners, I realised I mispronounced Jay Gould’s name as “Jay Gold”. It is “goold”, though we probably did have a lot of gold.