WILL THE FED PULL OFF A "SOFT LANDING" THIS TIME?
As 2022 begins, I’ve been reading a lot of commentary on the economy and Fed policy, which sounds like the old “soft landing” scenario. A soft landing is when the Fed is able to raise interest rates to slow the economy enough to relieve inflationary pressures, but still avoid a recession. While the Fed has yet to start a real tightening regime, the pressure is on to contain inflation, and the Fed has obliged by saying they intend to raise rates later this year. Since Alan Greenspan introduced a more graduated approach to raising rates in 1987, I’ve heard this soft landing story every time the Fed embarks on a tightening regime. In the past five tries, it’s only worked once, in 1994. As an eyewitness to the last five tries, I’m a little skeptical about it working this time too.
In each of the other cases, the Fed did raise rates enough to slow the economy, but the soft landing was derailed by an exogenous event. This happened in 1990 (Gulf War I), 2000 (the Tech Bubble), 2008 (the Global Financial Crisis) and 2020 (the Global Pandemic). I could also throw in 1987 (the Crash of ’87). We could make the case that the Fed raised rates too slowly in 2000 and 2008, resulting in those bubbles, but the Fed has stated in the past that bursting bubbles is not their job.
But, it worked in 1994. Why? A by-product of tighter central bank policy is a more fragile economic environment, one susceptible to shocks. In 1994, there were no shocks, likely because the market was fairly valued and the global geo-political environment was stable.
The same cannot really be said about 2022. Markets have had three years of double-digit returns while a global pandemic continues. The geo-political situation appears difficult with sabre rattling along the Ukrainian border by the Russians, China over Taiwan, and Iranian nuclear developments just to name a few. Add high inflation and the situation looks pretty precarious, and ripe for an exogenous shock. So, while a soft landing is possible in theory, the fragility caused by a tightening regime makes one the least likely event. We’ll see how it turns out this time once the Fed and other central banks get started.
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