outright contraction
gross domestic product
verdict
Treasury bond
docile
expenditures
petering out
spitting distance
running out of steam
crumple
intervene
hairier
outset
grew at a brisk
buttressed
shying away
The Elusive Soft Landing Is Coming Into View
Inflation news has been better than expected and there is no sign of recession, but consumers are starting to pull back
The U.S. economy is approaching what most economists had thought either unlikely or impossible: inflation returning to its prepandemic norm without a recession or even much economic weakness, a so-called soft landing.
“What we are expecting now is a soft landing,” said Nancy Vanden Houten, lead U.S. economist at Oxford Economics. “We expect the economy to weaken quite a bit, but it does look like we’ll avoid an outright contraction” in gross domestic product.
Six months ago, the consensus among economists surveyed by The Wall Street Journal was that the economy would enter a recession over the next 12 months. In October’s survey, the average forecast of economists was for no recession. After Tuesday, the probability appears to have dropped further. That, at least, seems to be the verdict of investors who sent stocks up sharply and Treasury bond yields down on news that inflation was surprisingly docile in October.
If they are right, it would be highly unusual. In the past 80 years, the Federal Reserve has never managed to bring inflation down substantially without sparking a recession.
The strong economic rebound following the pandemic pushed inflation to four-decade highs of 9.1% last year. In response, the Federal Reserve raised interest rates to a range between 5.25% and 5.5%, the highest level in 22 years. The Fed aims for 2% annual inflation using a different measure, the personal-consumption expenditures price index.
Inflation within spitting distance of 2%
October’s report, released Tuesday, showed inflation had come down to 3.2%. More encouraging, over the five months ended in October core inflation, which excludes food and energy, ran at a 2.8% annual rate, spitting distance from 2% and well below the 5.1% annual pace in the first five months of the year.
The big drop happened while employers continued to add jobs and without any obvious sign that economic growth was petering out.
In September, the Fed expected core inflation as measured by the PCE price index to end the year at 3.7%. Now, it appears it could fall to 3.4%, according to Omair Sharif, president of Inflation Insights, a research firm.
Still, a soft landing isn’t guaranteed. Inflation hasn’t made it all the way to 2%. The economy may yet crumple under the delayed impact of higher interest rates. Outside forces like energy prices or a financial crisis could intervene.
More noteworthy, the American consumer, whose spending has sustained recent growth, may be running out of steam. Retail sales fell in October for the first time since March, with major retailers such as
and
reporting a decline in sales this fall as customers pull back.
“It looks like a soft landing until there’s some turbulence and things get hairier,” said Nick Bunker, an economist at Indeed who studies the labor market. “You only know it’s happened once you’re on the ground.”
Slowing wage gains have reinforced the downward trend in inflation. Higher wages over time can feed into higher prices. But average hourly earnings were up 4.1% on the year in October, the lowest since June 2021 as companies compete less aggressively for workers.
“If one was looking for a clear sign of a soft landing, the disinflation inside the [consumer-price index] is one unavoidable and unmistakable sign that the U.S. economy has proved far more resilient than anyone anticipated at the outset of 2023,” said Joseph Brusuelas, chief economist at RSM US.
Until inflation is back to 2%, the Fed is unlikely to declare victory.
“We’re still very focused on the first question, which is: Have we achieved a stance of monetary policy that’s sufficiently restrictive to bring inflation down to 2% over time?” Fed Chairman Jerome Powell told reporters Nov. 1.
Investors declare victory over inflation
Yet investors seem prepared to declare victory, even if the Fed isn’t. Futures markets put the probability that the Fed will begin cutting interest rates by May at roughly 65% , according to CME Group data.
Meanwhile, other data over the past few weeks point to an economy that is still healthy.
Rather than slow down this year, growth has sped up, to 4.9% annualized in the third quarter, its fastest since the end of 2021. Economists expect growth to slow to around 1% in the final three months of the year and to about 1% in 2024.
Meanwhile, over the three months through October, U.S. employers added an average of 204,000 jobs a month, a marked slowdown from earlier in the postpandemic period but still above 2019’s average of 163,000. The unemployment rate has ticked up to 3.9% but remains low by historical standards.
A big question is whether consumers, whose spending powered the recovery, can keep it up.
Consumer spending grew at a brisk 4% annual rate in the third quarter. But much of that has come out of savings, which had been buttressed by pandemic-era stimulus programs. The saving rate fell to 3.4% in September from 5.3% in May.
One test will come during this year’s holiday season. The National Retail Federation expects consumer spending in November through December will rise between 3% and 4% from the same period last year. That would be smaller than the 5.4% gain posted in 2022 and the 12.7% jump seen in 2021.
Consumer spending at stores, restaurants and online fell 0.1% in October from the prior month, the first such decline since March, according to a Commerce Department report released Wednesday. Auto-dealership and furniture-store sales dragged down the overall figures, a sign that American households could be shying away from big-ticket purchases. Excluding autos and gasoline stations, retail and food-service sales rose 0.1% from the prior month.
Early warning signs also are developing in the labor market. The unemployment rate is up half a percentage point since April. Such an increase usually comes right before a recession.
Some warning signs in jobless claims
The number of people filing first-time jobless claims is bumping along at historically low levels, a sign that employers are still loath to lay off workers. But the number of people collecting unemployment benefits has climbed for seven straight weeks to nearly 1.6 million in the week ended Oct. 21, the highest since April, suggesting those unlucky enough to be laid off are finding it harder to find a new job.
There’s also a risk that higher interest rates have made many businesses and households more exposed to unexpected shocks, said Jeremy Schwartz, senior economist at Nomura. He expects a recession next year.
Higher borrowing costs will make it increasingly costly for businesses to refinance their debt, he said. Many small businesses are also scaling back their expansion plans. Household finances are also getting more precarious. The share of newly delinquent credit-card borrowers rose to 2% in the third quarter of this year, higher than before the pandemic, according to the New York Fed.
In such a fragile environment, a sharp rise in energy prices or a round of corporate defaults or bank failures could tilt the economy into recession next year, Schwartz said.
Write to David Harrison at david.harrison@wsj.com and Jeffrey Sparshott at Jeffrey.Sparshott@wsj.com
