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Article | 04 December 2023 | Investments
The latest financial market strength has been fuelled by a growing belief that major economies could enjoy a soft landing. What does this mean? In essence, it is the view that they will avoid any predicted recession, instead gliding gently into a period of lower growth with fewer inflationary pressures. We discover how recent macroeconomic history might have put us on the final approach to a soft landing.
After global economic growth fell off a cliff during the Covid pandemic, the recovery in many countries was sharp. The ‘reflation trade’ was all the rage, as markets looked to ride the rebound to trend growth. A wall of financial support, either in the form of government stimulus or a loosening of the monetary reins by central banks, ensured that financial market liquidity was never at risk. Crucially a credit crunch was avoided.
But the pandemic did bring a different problem. As ships were held in ports, trapping cargos on the wrong side of the world, global supply chains ground to a halt. A scarcity of parts meant that manufacturing production was squeezed. And a limited supply of finished goods, notably lockdown favourites such as consumer electronics, meant that prices started to surge. The result was the beginning of a wave of inflation.
Central banks favoured the term ’transitory’ for these inflationary pressures, meaning that only limited action was taken to check them. Fast forward to the invasion of Ukraine by Russia in early 2022. Energy prices soared, and inflation shot up to levels not seen for 40 years. The US Fed stamped on the monetary brakes and interest rate hikes came thick and fast. It resulted in the Fed’s most aggressive rate hiking cycle, a total of 525 basis points in around 18 months.
Inflation has since clearly responded. And western central banks have adopted a ‘higher for longer’ approach, keeping rates at a plateau. So what could interrupt the flight path to a more benign macroeconomic environment? The restraining effect of rate hikes on an economy is far from immediate. There can be a lag of up to two years before any pinch is felt. While central banks remain cautious for now, when interest rates are expected to fall bond markets typically respond positively. And a soft landing would suit equities far better than a recession.