“Soft landing process will likely be bumpy.” – Patrick Harker, Philadelphia Fed President

Equivocations and euphemisms create the equivalent of Rorschach inkblots that allow each listener or reader their unique interpretation. Harker’s “soft landing” seems to be exactly what a majority of market participants wish to hear. The “bumpy” part has my focus with my question being when does the Fed style book transition from “soft but bumpy” to “hard”?

In developing core themes for 2024, the major concerns of the last 2-years are most likely passed. The government transfer fueled lockdown recovery of 2H20 and 2021 which led to generationally high inflation has likely run its course. What followed in 2022 and 2023 was the rapid monetary tightening shock that caused economic contraction in 1H22 followed by a surprisingly resilient economic expansion.

Despite the economy tracking to 2.6% growth in 2023, the combination of 5.25 points of Fed target rate increases, $1.3T of Quantitative Tightening and 17.5% in cumulative consumer inflation led to the liquidity and duration mismatch banking event that peaked this past spring. While the broader equity market recovered to basically unchanged from January 2022, most bank indices are still lower by more than -20% over the same period. In my opinion the “soft landing” base case is already discounted in the market. When does something “bumpy” or “hard” become discounted is the question to solve?

I start with the argument that the resilient economic growth of 2023 is due in large part to unsustainable Federal deficit spending. Deficit spending was 11.8% and 5.3% of GDP in 2021 and 2022, respectively. The 2023 deficit will be close to 7% of GDP. Any honest analysis of economic growth will acknowledge the general public is not getting a good return on this investment. Deficit spending is bipartisan and will take a catalyst to change. Possibly a Moody’s U.S. debt downgrade or more equity selloffs triggered by bad Treasury auctions that take continually longer to recover?

The Conference Board Leading Economic Index (December 21) continues to indicate elevated recession risks that in my judgment should merit further discounting in equity prices. The Conference Board report included commentary noting, “The US LEI continued declining in November, with stock prices making virtually the only positive contribution to the index in the month. Housing and labor market indicators weakened in November, reflecting warning areas for the economy. The Leading Credit Index™ and manufacturing new orders were essentially unchanged, pointing to a lack of economic growth momentum in the near term. Despite the economy’s ongoing resilience—as revealed by the US CEI—and December’s improvement in consumer confidence, the US LEI suggests a downshift of economic activity ahead.”