Resources | Market Trends | July 28, 2023

More Economists Say a Recession-Free Soft Landing Could Become a Reality

An end to high inflation without the pain of a downturn? It might just happen.

A woman reacts to the news of a potential "soft landing"

An end to high inflation without the pain of a downturn? It might just happen.

After months of forecasts predicting a recession, more economists are now taking the possibility of an economic “soft landing” more seriously. A soft landing means that central banks will have increased benchmark interest rates enough to cool inflation without causing a recession.

And now, after several months of rate increases, it appears that might be happening. 

US consumer inflation was 3% in June on a year-over-year (YOY) basis, within striking distance of the Federal Reserve’s goal of 2%. Canada’s inflation was even lower, at 2.7% YOY. 

The most recent UK report of 7.9% inflation was well above the 2% goal, but the decrease was also more than expected. In June, the euro zone reported 5.5% inflation, about half what it was last fall. 

At the same time, many countries’ economies have proven to be fairly resilient. Consumer spending and hiring haven’t crashed as a result of the interest rate increases. In fact, the US economy grew by 2.4% in the second quarter, ahead of predictions. 

As a result, opinions have started to shift

How common are soft landings?

When an economy is experiencing high inflation, policymakers will often attempt to engineer a “soft landing” by gradually raising benchmark interest rates. The goal is to avoid a recession by slowing but not reversing economic growth. 

Examples of that type of soft landing are relatively rare. One occurred in the US in 1994 and 1995, when then-Fed Chairman Alan Greenspan raised interest rates to roughly 6%. 

But Greenspan was facing much different conditions than today’s Fed does. For starters, inflation was only 2.7%. Greenspan raised interest rates as a precaution, trying to prevent prices from increasing and derailing overall economic growth.

It’s important to avoid being too optimistic. Observers hoped for soft landings before recent recessions, to no avail.

Some experts argue the definition of a soft landing should be a little looser. Alan Blinder, a Fed vice chairman under Greenspan, argues that if the economy experiences a drop in gross domestic product (GDP) of less than 1% or if there’s no official recession within a year of Fed rate raising, then it should count as a “softish” landing

If that were the standard, almost half of the post-1965 and pre-pandemic Fed tightening cycles could be considered softish landings. 

What could still prevent a soft landing? 

It’s understandable why people are hoping for a soft landing, but there are still several reasons why a recession could still occur.

Overall economic conditions could deteriorate

The Conference Board’s Leading Economic Index — which helps show where the US economy might be headed — has been in decline for 15 months, the longest run of decreases since the period leading up to the Great Recession.

“We forecast that the US economy is likely to be in recession from Q3 2023 to Q1 2024,” said Justyna Zabinska-La Monica, senior manager, business cycle indicators, at The Conference Board. “Elevated prices, tighter monetary policy, harder-to-get credit and reduced government spending are poised to dampen economic growth further.” 

Hiring has remained strong, and wages are starting to rise, too. That could create enough demand to either keep inflation where it is now or even push it higher again. 

Rate hikes could go too far

In the US, the Fed is committed to bringing inflation down to its long-term target of 2%, and it is ready to do almost anything to achieve that, including more interest rate hikes. The Fed raised rates at the end of July by 25 basis points, and there is the potential for another increase by year’s end. 

In Europe, the ECB is on a similar path. It raised rates by 25 basis points in late July, a 22-year high, saying that inflation is declining but is still too high. Unemployment remains low, and energy prices have come down. Unfortunately, manufacturing is struggling, and food prices continue to increase.  

The banks’ rate increases aren’t large. But there’s always the chance that another hike, on top of the others so far, could tip the economy into recession. It takes time for rate hikes to have an impact — usually nine months or more — and it can be hard to predict how many increases will be too many.  

“This issue makes me concerned that they’ll hold interest rates steady or increase for too long and not be responsive enough,” said Chris Atkins, C2FO’s president of Capital Finance. “To do it right, I think they’ll need to start cutting rates very fast after inflation gets close to 2.5%, which I’d expect in the next couple of months.”

The economy experiences one or more external shocks

It’s one thing to engineer a soft landing when events proceed largely as expected. But a large external shock, like a natural disaster or political upheaval, usually can’t be predicted perfectly and can affect economic demand in ways that are hard for policymakers to manage. 

COVID-19, supply chain headaches, the war in Ukraine, climate woes, and on and on — the last few years have been one long chain of external shocks. There’s nothing to say another couldn’t be waiting to appear. China, for example, is dealing with several issues related to slow growth, geopolitics and real estate. If Europe experiences sharper pain, that could affect the US, too.

The bottom line on soft landings in 2023

Hope for the best, prepare for the worst. While a soft landing is an ideal ending for the world’s inflation woes, there’s still a good chance that recession will be unavoidable. To prepare, businesses should work to increase their working capital so they have the necessary funding to adapt to a period of lower revenues. C2FO can help — learn more about our suite of solutions.

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