The ongoing debate surrounding the potential for a “soft landing” of the US economy has captivated economists over the past year. As the Federal Reserve System (the Fed) grapples with the challenge of engineering a soft landing amidst soaring inflation rates and peaking interest rates, analysts remain cautious about the potential risks that could jeopardise a smooth economic descent.
Recent data indicates a promising trend, with the annual inflation rate steadily decreasing to below 4 percent from its peak in the summer of 2022. The Federal Open Market Committee (FOMC) left interest rates unchanged at 5.25–5.50 percent in January, signalling a potential end to the aggressive rate-tightening cycle initiated in March 2022. However, the FOMC remains cautious, stating that a rate cut will only be considered when there is greater confidence that inflation is moving sustainably towards the 2 percent target.
Despite positive indicators, key downside risks persist, keeping the possibility of a recession and more severe outcomes for businesses and households on the horizon. A National Association for Business Economics (NABE) survey revealed that 91 percent of economists see a 50 percent probability or less of the US entering a recession in the next 12 months, a significant increase from previous surveys.
Government spending has played a crucial role in supporting the US economy, contributing to a recent acceleration in GDP growth. However, economists caution that the proper drivers of this growth might be illusory, particularly with exorbitant government spending in recent years. The widening federal deficit and higher government spending as a share of GDP raise concerns about the sustainability of the current growth trajectory.
While a strong job market and consumer spending have supported the recent increase in GDP, worries about ongoing inflation loom. Inflation expectations have risen with solid job market performance, challenging earlier predictions of a rate cut in March. Economists suggest that the labour market may need to cool before inflation eases, emphasising the importance of a balanced approach.
Geopolitical tensions, especially in the Middle East and Ukraine, pose additional risks to commodity prices and supply chains, potentially disrupting economic stability. The International Monetary Fund (IMF) warns that these geopolitical factors could extend central banks’ monetary-tightening actions, contributing to a more challenging soft landing.
Despite uncertainties, most analysts anticipate the Fed will begin trimming rates from the second quarter onwards. The positive growth outlook for the US, supported by fiscal measures and consumer spending, strengthens the case for a gradual easing of monetary policy. The IMF’s recent upgrade to the US growth prospects further underscores the potential for a successful soft landing.
However, the delicate balance between inflation control, economic growth, and external risks keeps the Fed on high alert. As the economic debate continues, policymakers must navigate uncertainties and carefully calibrate their actions to achieve a soft landing and avoid more turbulent economic outcomes.
