- The Federal Reserve would like to achieve a so-called soft landing by slowing down the economy without triggering a recession.
- According to David Rosenberg, the chief economist at strategist at Gluskin Sheff, this is looking highly unlikely.
- His charts below lay out some of the economy’s most vulnerable spots, explain why it may be too late for the Fed to avert the next recession, and highlight parts of the market that have historically done well during downturns.
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The Federal Reserve has undoubtedly played a key role in juicing this economic expansion and enabling a historically long bull market in stocks.
But with nascent signs of an economic slowdown, the Fed’s capacity to fight the next recession is being called into question.
At issue is whether the Fed can achieve another so-called soft landing, which happens when the Fed raises interest rates sufficiently enough to avert an overheated economy and stops tightening soon enough to avoid a recession. The last time this happened was in the mid-1990s, when the Fed successfully paused its hiking campaign — as it has now — before resuming.
Not everyone thinks the Fed will be able to engineer a slowdown without a recession, including David Rosenberg, the chief economist and strategist at Gluskin Sheff.
His table below provides the first reason why: Historically, Fed rate-hike cycles have been followed by recessions, not soft landings.
The other big bone of contention that Rosenberg has with the Fed lies in how it has shifted the estimate of what it considers the neutral rate. "Neutral" refers to a theoretical level of interest rates at which the Fed has basically achieved its goals: prices are stable, there’s full employment, and the economy is neither slowing nor accelerating.
The Fed has consistently lowered this estimate — also known as the terminal funds rate — since the Great Recession. But, as Rosenberg points out, the most recent recent haircut placed it within one more hike of its current benchmark rate. In other words, the Fed is signaling that this source of rocket fuel for the economy is running close to empty.
Looking beyond the particulars of the Fed’s decisions, Rosenberg has identified several parts of the economy that investors should be watching closely.
The first place to watch is the interest-rate market, which is immediately impacted by Fed policy. Much ado has been made of the inverted yield curve, or the difference between 3-month and 10-year Treasuries that recently turned negative. Similar inversions have preceded every US recession since the 1950s, and this episode sent the New York Fed’s recession-probability model to an 11-year high.
The corporate-debt market is another sore spot.
Looser regulations since the 2016 elections have spurred many companies to arrange financing to grow their businesses, and a record $1.8 trillion in corporate debt is coming due in 2023, according to data compiled by Bloomberg. This borrowing binge has in turn driven corporate debt to historic and potentially ominous highs relative to gross domestic product, as the chart below shows.
The problem is not just in the sum of debt — it’s the fact that many of these companies may be unable to repay their debt if the economy slows.
What others are saying
For now, stock-market investors are taking their cue from the ongoing pause in interest rates, and are exuding confidence that the immediate future is rosy. Despite all the recession talk, the market is back within shouting distance of an all-time high, following the late-year correction that was spurred by concerns about high interest rates.
Also, there aren’t many economists or investors who are willing to mention the dreaded ‘r’ word at the first signs of a slowdown. Apart from the reputational threat of being wrong, there’s a technical one: recessions have no start date that’s easy to pinpoint ahead of time. They are subjectively determined by the National Bureau of Economic Research, which always makes the call after the economy is already speeding in reverse gear.
But there are other pundits like Rosenberg who are willing to shout at the first hint of smoke, even before the fire is obvious. And he doesn’t stop there: his chart below shows how various asset classes have historically stacked up during recessions, and could serve as a starting point to prep for the next one.
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