Is Soft Landing Optimism Just Wishful Thinking?

While the Federal Reserve may be approaching a rare soft landing, the battle against inflation is not yet won without costs. First, inflation remains firmly above the Fed's two percent target, and the substantial Treasury debt issuance suggests that interest rates could stay elevated for an extended period. However, there are significant challenges looming on the horizon.

Wall Street's outlook for 2024 appears optimistic. Nevertheless, 2024 may not be a year to disregard caution.

Household debt has surged. Since interest rates began rising at the end of 2021, credit card delinquency rates have increased, with delinquency rates for young people nearing levels seen during the 2007-09 global financial crisis. Over the past year, credit card and auto loan balances have reached record highs. Credit card balances alone increased by $48 billion in the third quarter alone, representing a 4.7 per cent quarterly increase – a pace that is clearly unsustainable. Depleted savings could also result in struggling consumers in the year ahead.

Thus far, robust wage growth has supported consumer finances. However, the labor market is cooling. Over the past year, employment gains and wage growth have not been widespread. Government, social assistance, and healthcare accounted for nearly 60 per cent of all employment growth in 2023.

Moreover, a record amount of debt needs to be refinanced at higher rates for many non-financial companies in 2024, which could constrain business investment, hiring, and wages. According to the financial research firm Calcbench, some of the largest non-financial companies in the S&P 500 have a combined $107.7 billion in debt coming due this year. Moody's has also analyzed the data and estimated that $3.1 trillion of debt will mature in the next four years. Adding to these concerns, banks this year stand to lose about billions from commercial real estate since up to 20 per cent of all commercial - office - real estate could default.

Additionally, there's the matter of a US election. First, there's the political polarization in Washington DC and economic policy uncertainty (EPU) associated with election-year politics. This is likely to lead to a significant decline in investment spending in the second half of this year, extending well into the next year. To put it in perspective, an increase in EPU from the current level to the one observed during the 2020 election cycle could subtract 3-4 points from real GDP growth, potentially pushing the US economy into a recession. And this time around there would be little monetary and fiscal space to rescue a struggling US economy.

Moreover, leading candidates from both political parties are leaning toward more protectionist trade policies, which could slow economic growth and exert upward price pressures, regardless of the election outcome.

Lastly, ongoing geopolitical turmoil and prolonged armed conflicts are already taking their toll. The wars in Ukraine and the Middle East have pushed up food prices, altered shipping routes, caused trade disruptions, and are likely to continue diverting economic resources away from other critical investments. Wars tend to result in higher commodity prices and lower growth.

While the most anticipated recession ever did not materialize in 2023, economic growth is expected to decelerate this year and could remain weak for the rest of the decade.

Dr Orphe Divounguy
Orphe Divounguy is a Senior Economist at Zillow Group Inc. Divounguy is the former Chief Economist at the Illinois Policy Institute. Divounguy is also the founder of the Quantitative Research Group and the co-host of the Everyday Economics podcast. Divounguy’s columns and articles cover fiscal policy, labor economics, and quantitative methods for programme and policy evaluation. Contact: orphe@policyquants.com. The views presented here do not necessarily reflect the views of his employers.