The case for a US recession has been slowly collapsing as inflation eases and the economy holds remarkably steady, despite 11 interest rate hikes since the Federal Reserve began its latest battle against inflation in March 2022.
Indeed, Bank of America became the first major Wall Street bank to revoke its forecast of a recession last week, joining Fed economists who also no longer expect a recession.
Squashing inflation without throwing the economy into recession is what's called a "soft landing," something the Fed has only achieved once in the past 60 years, though some research argues the central bank has done it more often. But aside from simply skirting a recession, it's not obvious what the economy would look like in a soft landing.
How would economic growth and the job market look? And who even declares that the Fed has officially defied the odds and achieved a soft landing?
The main aspect of a soft landing, according to economists, is the absence of a recession, which is determined by the National Bureau of Economic Research (NBER.) That means gross domestic product — the broadest measure of economic output — can't contract for more than a few months at a time at most. It's a key data point the NBER considers when making a recession call, in addition to also considering employment, household income and industrial production.
And since consumer spending accounts for about two-thirds of US economic output, a dramatic pullback in consumer spending would inevitably weigh on GDP. So spending and economic growth typically go hand-in-hand.
"We would want to see continued strength in consumer spending helping to support overall GDP growth and business investment, and so far, we've had those things in place to some degree, even though they've trended slower," said Kayla Bruun, senior economist at Morning Consult. "I'm looking for the NBER to determine whether the US has officially entered a recession or not, which we might not know for several months or maybe even a year after the fact, so we won't know if we've had a soft landing until then."
But with economic growth, as measured by gross domestic product, averaging more than a 2% annualized rate in the first two quarters of the year, the US economy is still on strong footing. In fact, the Atlanta Fed's real-time GDPNow tracker estimates GDP growth of a staggering 3.9% annualized rate in the third quarter. With the third quarter already underway, the US economy would have to sharply deteriorate in the coming weeks to begin a recession, which is highly unlikely.
In a soft landing, the job market has to remain intact. That means there should be low unemployment and strong (but not too strong) job growth.
"In layman's terms, 4% unemployment is a sort of a magical dividing line because when unemployment is below 4%, we see a whole bunch of things happen in the economy," said Julia Pollak, chief economist at ZipRecruiter. "With unemployment below 4%, we see participation (in the job market) pick up because the labor market is sufficiently tight that employers raise wages, improve benefits, improve working conditions and recruit more broadly." Pollak said a soft-landing labor market would resemble the one between 2015 and 2019.
The unemployment rate fell to 3.5% in July, according to the Labor Department's jobs report on Friday. Before the pandemic, the unemployment rate reached a half-century low of 3.5% in February 2020.
The other key feature of a soft landing is for the Fed to successfully control inflation, but that's open to some interpretation. Some say that simply means for inflation to fall to 2%, which is the Fed's official target. Others say inflation can settle slightly above 2%.
"I don't think 2% is necessarily a key threshold because I think the Fed would be more than happy to see a 3% as long as we see inflation come down," said Josh Markman, partner at Bel Air Investment Advisors.
It's unclear how common Markman's opinion is among investors. And it is possible for the Fed to raise its inflation target, but most economists say that's unlikely. The conventional wisdom is that the Fed wouldn't like inflation above 2% for too long because consumers might then expect higher and higher prices, starting a new era of faster inflation. The Fed is still mulling one last rate hike this year, even though the Fed's preferred inflation gauge — the Personal Consumption Expenditures price index — rose 3% in June from a year earlier.
So who determines if the Fed pulled off a soft landing? It's the NBER and the Fed that both would make the call.
The central bank at some point would have to acknowledge that inflation has come within target — whether that's the current 2% target or a new one — and begin to focus equally on its other mandate, to keep the job market humming and sustainable. That would be victory.
The Fed liked the July jobs report, though wages grew faster
Top Federal Reserve officials cheered the job market's cooldown in July, even though wages grew at a stronger clip.
The Labor Department's jobs report released on Friday showed that average hourly earnings rose a robust 4.4% in July from a year earlier, which some analysts depicted as a pesky problem for the Fed.
But not so much with Federal Reserve Bank of Chicago President Austan Goolsbee.
Wages "are not a leading indicator of price inflation," Goolsbee said in an interview with Bloomberg. "I think if you want to know if you're beating inflation, go watch the inflation."
Atlanta Fed President Raphael Bostic expressed a similar sentiment, adding that he's comfortable with the economy's steady cooldown.
"It doesn't surprise me that wages are still strong," he told Bloomberg. "During this whole high inflation period, worker wages have trailed inflation for quite some time, and so we're still in that catch-up period, and I expect that we will still see strong wages."
Wages have been feeding into inflation, but the extent is debated by economists. The Fed also puts more weight on the quarterly Employment Cost Index, which showed that pay gains cooled in the second quarter.
Up Next
Monday: Earnings from Tyson Foods and Beyond Meat. Federal Reserve officials Michelle Bowman and Patrick Harker deliver remarks. The Federal Reserve releases June figures on consumer credit.
Tuesday: Earnings from UPS, Lyft, Under Armour, Fox and Restaurant Brands, The National Federation of Independent Business in the US releases its Small Business Optimism Index for July. The US Commerce Department releases June figures on imports and exports. China's National Bureau of Statistics releases July inflation data.
Wednesday: Earnings from Disney and Wendy's.
Thursday: Earnings from Ralph Lauren. The US Labor Department releases its Consumer Price Index for July along with weekly data on worker filings for jobless benefits.
Friday: The US Labor Department releases its Producer Price Index for July. The UK's Office for National Statistics releases second-quarter gross domestic product data. The University of Michigan releases a preliminary reading of consumer sentiment for August.
