Key Takeaways:
Historical precedent leans toward a recession in 2025
Does AI change this outcome?
The US equity multiples are high (expensive) but debt maturities have been pushed out by corporations.
The prevailing question facing economists this year centers on the trajectory of the U.S. economy: will it experience a soft, hard, or no landing at all? Each scenario carries plausible reasoning:
Possible Outcomes for the U.S. Economic Outlook
Reacceleration (No-Landing) Scenario:
Supported by above-trend job growth, anticipated double-digit corporate earnings growth, and inflation lingering above 2.5%.
Soft Landing or Below-Trend Growth:
Indicated by slowing labor market indicators, such as hiring rates and wage growth cooling. Signs of stress among low-income consumers, such as rising default rates on credit cards and auto loans, further bolster this scenario.
Hard Landing (Recession):
Historical precedent and current indicators like the Fed's aggressive tightening (similar to Paul Volcker's era) and an inverted yield curve since mid-2022 suggest a looming recession. Previous instances of sustained restrictive monetary policy have typically led to economic downturns.
Assessing the Most Likely Economic Path
A "no-landing" outcome appears improbable as economic indicators point to a slowdown, with inflation pressures easing due to diminished pandemic savings and the fiscal boost from the Inflation Reduction Act of 2022 turning into a drag. Despite recent upticks in core inflation measures, ongoing moderation in wage growth is expected to eventually stabilize inflation within the Fed's target range of 2-2.5%.
Soft Landing or Recession?
The primary debate hinges on whether the economy is poised for a soft landing or recession. Economic data are ambiguous: signs of deceleration could signify a healthy adjustment that curbs inflation without triggering negative growth, or potentially foreshadow a mild recession starting late this year or in early 2025.
The case for a soft landing argues that unique factors distinguish this cycle, such as responsible borrowing by households and firms locking in low interest rates. Despite Fed tightening, the gradual economic slowdown has managed to curb inflation without precipitating a recession. However, the resilience of the economy could inadvertently delay necessary Fed rate cuts, making a hard landing increasingly likely.
Market Perceptions and Risks
Financial markets currently favor a soft-landing scenario, evident in optimistic earnings-growth projections and low credit spreads suggesting minimal default risks. Yet, the potential for a mild recession is underestimated, posing asymmetrical risks to market returns: while a soft landing could yield gains, a recession could trigger significant market declines.
Global Economic Landscape
Internationally, most developed economies are recovering, with Europe rebounding from near-recession conditions in 2023, supported by global manufacturing upturns and increased bank lending. Similarly, Japan and the UK show promising economic indicators despite challenges like persistent inflation.
Long-Term Implications of AI on Economic Growth
Looking ahead, the integration of artificial intelligence (AI) presents divergent views: while skeptics like Daron Acemoglu foresee modest GDP boosts, optimists project substantial gains akin to historical technological advancements like electricity and the internet. AI's potential to enhance productivity through efficiency gains and task reallocations underscores its transformative economic impact.
Conclusion
As mid-2024 unfolds, the U.S. economy stands on firmer ground with moderating inflation and robust corporate earnings. While a recession within the next year remains plausible, current economic trends and market conditions suggest a soft landing is more likely, albeit with significant uncertainties. Investors are advised to monitor closely for any indicators pointing towards deeper economic downturns.
Source: Adapted from financial analysis and economic forecasts as of mid-2024.
Sources and Disclosures: