Why do some experts associate the economic downturn with aviation?
In economics, as in aviation, terms such as "Soft Landing", "Hard Landing" and "No Landing" are used to describe the possible scenarios they may face, based on how interest rates and monetary policy are managed.
A "Soft Landing" in economics, similar to a controlled descent in aviation, suggests a smooth economic transition into a slowdown without going into recession. On the other hand, a "Hard Landing" in economics indicates an abrupt stop or recession, similar to an abrupt landing in aviation that may result in damage or negative consequences.
"No Landing" describes a situation where the economy continues to hover, keeping interest rates unchanged, creating uncertainty by not defining a clear direction. This scenario captures the idea of an economy that neither adjusts toward sustainable growth nor enters recession, but rather somewhere in the middle.
The Federal Reserve, like a pilot, must make critical decisions that affect the outcome of economic 'flight', especially in relation to inflation and economic growth.
Why is the U.S. economy in "a flight"?
Its trajectory and landing point are still uncertain. This is because, as of 2022, Jerome Powell, the Federal Reserve chairman, has taken the controls, to guide the economy in its fight against inflation.
Just as flights are monitored by radar, the economy is also under constant observation. We have tools and data, similar to a 'flight schedule,' that allow us to track its progress and anticipate possible turbulence or changes in route. While we cannot accurately predict every move, these tools provide us with crucial information to understand and react to the evolving economy."
Expectations for rates and the economy
The Federal Reserve's (Fed) 2% inflation target was missed in December 2023, when inflation reached 3.4%, exceeding expectations. This outcome influenced economic forecasts, moderating expectations for a March 2024 interest rate cut. Previously, anticipation of these cuts had driven a significant increase in the S&P 500 in November, evidencing the impact of market expectations.
On the other hand, the US economy continues to show resilience. Q4 2023 GDP grew by 3.2%, supported by an increase in government spending of 4.2% and consumption of 3%. The latter is important as it reflects the strength of the labor market, with an unemployment rate of 3.7%. High interest rates have not significantly affected employment, allowing consumption and thus inflation to be maintained.
In this context, the expectation of a rate cut has been adjusted to June 2024, with a probability of 57.3%. However, September this year appears to be the month with the highest probability of a cut, at 69% according to Bloomberg data.
Recession: "Hard Landing or No Landing".
The strong labor market and robust consumption are driving U.S. GDP growth, leading economists to project a 2.1% increase by 2024. This outlook has changed significantly since early 2023, when many were anticipating a recession. Now, the probability of a recession in 2025 has been reduced to 40%, the lowest since 2022, making the possibility of a "Hard Landing" and recession seem less likely.
As for the "No Landing" possibility, where the Fed would hold rates steady awaiting further evidence of a slowdown in inflation, markets now see this as more feasible because of the U.S. economic strength. However, according to Deutsche Bank, this possibility, although it has increased, remains low, estimated at between 10% and 25%.
A "Soft Landing" scenario is considered the most likely scenario. Morgan Stanley notes that, based on current economic data, the U.S. economy could be experiencing this soft landing, reflecting a stable economic transition without entering recession or experiencing severe turbulence.
Election 2024: Biden, Trump and the fiscal deficit
In 2024, a significant election year, more than half of the world's population, including Americans, will participate in elections. Joe Biden, the current president, and Donald Trump, who is leading in the polls without yet being the official candidate in the primaries, are central figures in the U.S. presidential race. The performance of the economy will play a crucial role in influencing voter preference and thus determining the outcome of the election.
The United States faces the challenge of fiscal imbalance, with deficits projected at 8% by 2024, one of the highest levels compared to other developed countries. This imbalance, coupled with disagreements in Congress and the recent downgrade of the U.S. debt credit rating to AA+ with a stable outlook by Fitch Ratings, could negatively influence public perception of Biden's economic management in a key election year.
These economic factors, along with political dynamics, will be determining factors in the 2024 electoral climate, potentially affecting campaign strategies and candidates' priorities as they strive to win favor with the electorate against a backdrop of increasing economic challenges.
S&P 500 in election years
Goldman Sachs' analysis of more than 1,000 election processes globally suggests that elections often influence monetary policies and add uncertainty to the economic environment, and the United States follows this trend. During election periods, it is common for the Federal Government to increase its spending above its revenues and for there to be a tendency toward easing monetary policy, including interest rates. These actions often have a direct impact on financial markets.
Specifically, looking at the total annualized returns of the S&P 500 during election years since 1928, an average return of 11.6% is noted. This indicates that, historically, election years tend to be positive for financial markets. This pattern reflects how anticipation of government policies and speculation around election outcomes can influence investor confidence and market dynamics.
Trump effect?
In 2016, the election of Donald Trump as President of the United States took markets by surprise, given Hillary Clinton's lead in the polls. This initial surprise caused volatility, but markets quickly stabilized, with the S&P 500 closing November up 6.7% and an annual return of 9.5%, sustaining a rally into early 2017.
In the current context, the dynamics are different. Trump is leading in the polls, which reduces the surprise factor compared to 2016. In addition, the global economic scenario has changed significantly, facing challenges such as the situation in Ukraine, instability in the Middle East and developments in artificial intelligence, which could influence market reaction differently than it did in 2016.
In terms of economic policy, one of Trump's key proposals is to increase tariffs on imports, which could strengthen the dollar. This focus on trade seeks to reduce the trade deficit and improve the U.S. trade balance, which could also have a significant impact on financial markets and the global economy.
Conclusion
The U.S. economy is navigating an airspace full of variables, with crew and passengers attentive to the direction this crucial flight will take. While "Soft Landing" seems to be the most likely destination, the possibility of "No Landing" cannot be ruled out.
In addition, the potential arrival of a new pilot towards the end of the year could mean a change in the flight plan. Thus, this economic journey is at a turning point, where every decision in the cockpit will have a significant impact on the final destination of the flight.
This article was written by Daniel Zalles, Maycol Nuñez y Rafael Zarateall members of the Singular.
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