On track for a soft landing?

Please note: This article is more technical in nature than our typical articles, and may require some background knowledge and experience in investing to understand the themes that we explore below.

All data referenced in this article are sourced from Bloomberg unless otherwise stated, and is accurate at the time of publishing.

Key points

• While there have been wild swings in some financial markets’ valuations in the summer, all in all little has changed, economically speaking
• That said, the US central bank seems to be ready to start trimming interest rates. Possibly in September. However, the road to the terminal rate will be full of twists and turns
• Signs of weakness in Western economies have emerged. While growth appears set to slow, not least in the US, a recession seems unlikely for now. Instead, central bankers could be on the cusp of pulling off a ‘soft’ landing, where long-term growth potential returns to the norm
• Inflection points can be destabilising, as policymakers and economists adjust their forecasts to the new era. Add in a US presidential election and tense geopolitical flashpoints around the world, and navigating the next few months will require composure

Anyone switching off from events in financial markets over the summer may wonder what all the fuss has been about. All considered, not much has changed since June. 

Indeed, the most recent developments have only reinforced our view that the global economy, and the US in particular, should slow without falling into recession, while inflation weakens and, ultimately, interest rates fall in the months ahead.

Not much to see here

In terms of the markets, at the time of writing, the S&P 500 is essentially flat since June. The same can’t be said about the US 10-year government bond yield, which has dropped some 40 basis points (bp). Similarly, the US yield curve has steepened, from -50bp to around -10bp over the same period. This appears to reflect heightened concerns around domestic growth, plus more confidence of rate cuts coming soon.

Despite rebounding in the second quarter, with real gross domestic product (GDP) growing at an annualised rate of 3.0%, after 1.4% in the first quarter, the US economy is showing signs of weakness. This is most notable in the labour market, where the unemployment rate has continued to climb.

Consumption, meanwhile, has been surprisingly strong. That said, rising credit card delinquencies suggest that the consumer is running on fumes, especially at the lower end of the income distribution. 

Elsewhere, the eurozone has recovered, if very modestly, after a difficult 2023. This momentum looks set to continue, but investors shouldn’t expect fireworks with real GDP expansion likely to remain below 1% for the remainder of this year. 

The UK, on the other hand, is a relative bright spot, helped by renewed political stability. Here too, all the indications point to accelerated growth in the second half of this year.

Finally, the Chinese economy is struggling to burst into life, with local authorities continuing to offer piecemeal support that hasn’t impressed investors nor triggered a sharp rebound in growth. As a result, real GDP growth is likely to be on the lower side of the government’s 5% target this year.

Rate cuts come into view

With growth in the largest economies either slowing or below potential, it’s not surprising to see inflationary pressures ease. Although base effects could lead to some bumps, as the end of the year nears, the direction of travel is clear. 

Central banks, chief among them being the US Federal Reserve (Fed), have started to pivot away from a myopic focus on inflation to a more balanced approach, considering the increasing risks to growth. This has left the European Central Bank and the Bank of England trimming rates while the Fed has telegraphed a first cut coming later this month.

However, the pace and amount of rate cuts depends on many factors, including how quickly economies slow. One thing is likely though - rates won’t stay at the ‘neutral rate’ for an extended period of time. 

Interestingly, markets seem to believe that the fed funds rate will hover between 3.0% and 3.5% for most of 2025-2027. While possible, this scenario appears improbable and rates will likely either under- or overshoot this level. 

Bar a major inflationary shock, lower US rates are our base case. The same is true in the eurozone (2.0-2.5%) and to some extent in the UK, although there, the market prices in gradual decline in rates rather than a stabilisation.

Recession or reacceleration?

Outside of the implications of November’s US presidential election, investors will spend the next few months pondering whether a (US) recession is approaching. Judging by the recent deterioration in the job market, the risk of a recession has increased. However, this is to be expected: as growth slows, so too the risk of two consecutive quarters of negative real GDP expansion increases. 

As such, a recession is possible. That said, if one occurred, it would likely be relatively mild. Central banks have (much more) room to stimulate their economy should the need arise, than was the case a few years ago.

On the other hand, a ‘soft landing’ remains a base case for many pundits. Unfortunately, there is no clear definition of what ‘soft’ means. If it relates to growth stabilising to more normalised levels (that is, towards the long-term growth potential of a given region or country) that seems reasonable. If, instead, it means that growth reaccelerates, this seems far-fetched, at least in the short term.

The implications of inflection

Coming months are unlikely to be plain sailing. Major central banks (except maybe in Japan) are in, or are about to initiate, a cutting cycle which will create a new paradigm. While lower rates should stimulate economies, expectations of weaker policy could force businesses to delay investments and consumers to put off purchases. At the same time, if growth speeds up then inflationary pressures may resurface, or at least that is what could scare markets at times.

Inflection points are often challenging. They tend to upset economists’ forecasts and spark heightened volatility in markets. Add to the mix a tight race to the White House, a world that is swimming in debt and worrying geopolitical tensions, and forecasting what the global economy will do becomes even more difficult than usual. 

Yet, all this uncertainty should bring opportunities for investors. Staying nimble will be key as economies move towards a lower growth, lower inflation and lower rates environment.

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