Europe and the US caress the dreamed 'soft landing': the economy resists the abrupt rise in rates

In the years immediately following the historic financial explosion of 2008, the IMF, the OECD and the rest of the large international organizations were optimistic. Semester after semester and year after year, reality called into question the growth forecasts, which were systematically long. That bias has been reversed in recent times: the energy crisis has compromised European growth, starting with Germany, but without bringing the bloc to its knees, as feared. With all possible caution – the economy is always a story in real time and if recent years have taught anything it is that anything is possible – the macro players are showing an unprecedented capacity for resistance against rising interest rates. steepest in four decades.

Imbued with pessimism, the economic world cornered the soft landing hypothesis—which depicted an economy capable of digesting inflation and the escalation in the price of money without suffering a major recession—to the domains of the most unredeemed optimists. Months later, however, that niche theory is one step away from becoming something tangible. Growth slows on both sides of the Atlantic. But hold on. Thanks, above all, to a labor market that is much more buoyant than ever thought and to household consumption that is weathering the storm with flying colors in an environment of sharply rising credit prices.

If you had to choose a single word to describe the economy in 2023, it would be, without a doubt, resistance. Inflation is once again approaching reasonable figures and the first rate cuts by the Federal Reserve and the European Central Bank (ECB) in sight allow us to venture a much more benevolent economic horizon for the coming months. Reality is not a bed of roses but, in short, it is far—and very far—from the “blood, sweat and tears” that was suspected.

“Everything indicates that we are going towards a soft landing, a scenario that the markets are also seeing clearly in recent weeks,” says Xosé Carlos Arias, professor of Applied Economics at the University of Vigo. “The feeling is that we are converging towards the 2% inflation objective and that fears of price spirals are converging.” Everything is still in the always swampy terrain of “it seems,” because the economy has become a minefield for analysis. “But one thing is clear: the astringent monetary policy has not translated into a strong recession, and any comparison with the crisis [del petróleo] of the seventies has been exaggerated,” Arias ditches.

Mitigants

“We can still see some quarters with stagnation or slight decline, especially in the US, but not the major recession that was feared,” he completes. Leopoldo Torralba, attached to the chief economist of Arcano Research, one of the firms that has been most correct in its recent forecasts. “Historical experience said that, when rates rose so much, it was difficult to avoid recession. But this has been a very crisis sui generis“Unlike in other episodes in the past, this time there were no major imbalances, and there were many mattresses that have cushioned the shock.”

These mitigating factors can be basically summarized in three: the accumulated savings, which has allowed many families to maintain their consumption; private debt (households and companies) at reasonable levels, which has avoided a financial explosion like the one 15 years ago; and a much better prepared bank, with measures to deal with a default rate that – furthermore – has not taken off as feared.

“It has not been a crisis of demand, but of supply, with factors that we believed were going to correct themselves,” Torralba explains. For the coming months, this economist foresees a gain in household purchasing power “sooner than expected, as inflation continues to normalize,” and the first rate cuts in the US and the eurozone starting in the second or third year. quarter of this year. Result: “Demand will be sustained and the economy will endure.”

The Fed avoids claiming victory

In his memoirs, Alan Greenspan, president of the Federal Reserve from 1987 to 2006, highlighted as one of his greatest successes having achieved the long-awaited soft landing with the 1994 rate hikes, a term that comes from the space race between the United States and the Soviet Union in the 1970s that had not been used until then at the Fed, he explained. The current president, Jerome Powell, has been seeking to emulate him for more than a year and a half.

After many months in which recession forecasts were delayed but remained the central scenario, Powell began to taste success a few months ago. He stressed that in the United States the decline in inflation had occurred without a significant increase in unemployment, which remains below 4%. The forecasts of the members of the monetary policy committee of the US central bank for 2024 published in December anticipate the desired scenario: growth of 1.4%, an unemployment rate of 4.1% and inflation that is close to the target of the 2%.

Powell, however, is reluctant to claim victory. This Wednesday, Tom Barkin, president of the Richmond Federal Reserve, used the metaphor to expose the risks. “A soft landing is increasingly conceivable, but by no means inevitable. I see four risks. The US economy could run out of fuel. We could experience unexpected turbulence. Inflation could stabilize at a cruising altitude above our 2% target. And the landing could be delayed if the US economy continues to defy expectations,” he pointed out in a speech in Raleigh (North Carolina).

The risk of running out of fuel… Or of going to the wrong airport

By running out of fuel, Barkin refers to the possibility that the delayed effects of monetary tightening take their toll and that the pool of savings accumulated in the pandemic stops feeding demand. Turbulence can be geopolitical, financial or other types. In his opinion, it would be a mistake to “take the wrong airport” and think that it is okay to land at 3% inflation.

Both in the United States and—especially—in Europe, however, there is a growing criticism about the speed with which interest rates have risen. Perhaps, many say, too quickly in the face of an inflationary phenomenon that has many more supply than demand factors behind it. The ECB defends itself: “The latest inflation data from the euro zone are good, in line with what was expected, and the economy is following the soft landing script,” they said at the beginning of November from the president's entourage, Christine. Lagarde. Eurozone inflation closed December at 2.9%, slightly higher than in November but also below what analysts expected. And, above all, light years away from the worst days of the price crisis.

“The airport is on the horizon. But landing a plane is not easy, especially when the sky is cloudy, and headwinds and tailwinds can affect the course. It's easy to oversteer and do too much or understeer and do too little,” said Barkin. And he warned: “There is no autopilot.”

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