Over the last few weeks, the Federal Reserve governors have talked about attempting to achieve a “soft landing” for the U.S. economy. New York Fed President William Dudley has discussed how hard it is to accomplish this.
It ‘s not easy to achieve because of the tug of war the Fed plays between inflation and growth. On the one hand, they have to prevent the economy from overheating to the point that inflation rises above two percent. With the labor market as tight as it has become, it would be all too easy for markets to overshoot and inflation to rise significantly.
The Fed tries to fight this by raising interest rates. They have penciled in four for the year under Fed Chair Jerome Powell. The problem is that by tightening too much, they risk contracting national gross domestic product and kicking off a recession.
Managing to walk the fine line in between the two extremes is a successful soft landing. Accomplishing it requires both intelligent policies and also a hefty dose of luck. They have only manged to accomplish it one time in the Federal Reserve’s hundred year history. This is worrying to say the least.
Their one successful attempt at a soft landing happened under former Fed Chair Alan Greenspan in 1994-1995. The Federal Reserve doubled interest rates from three to six percent. Somehow this managed to slow down the nation’s economic growth without destroying it.
Yet there were still consequences from their intervention at the time. Bond investors suffered enormous losses. The Mexican financial crisis also ensued as a result. Orange County, California went bankrupt. It was hardly what you would call free of consequences.
For the Fed to successfully pull off a soft landing a second time would be harder today than it was when they did it right in 1994. At that time the job market was less tight and unemployment was higher than now. Our jobless rate at only 4.1. percent today is lower than the rate most economists believe is sustainable in the long term.
Attaining such a soft landing would require slowing down the growth and increasing the unemployment. New York Fed President Dudley has explained that any time unemployment has increased by in excess of from .3 to .4 percentage points, the U.S. economy “has always ended up in a full blown recession.”
The Federal Reserve officials privately worry that the long lasting period of low interest rates boosted the (especially equity) asset prices’ bubble to a point that can not be sustained. This occurred previously just over a decade ago as home prices rose shockingly high and then disastrously imploded. The bubble this go-round encompasses both stock and bond prices (in particular corporate bonds).
Is Your Retirement Portfolio Prepared for a Failed Soft Landing Crash?
Greenspan has warned that today’s stock and bond market levels are well into bubble territory. Assuming he has again called the “irrational exuberance” correctly, both bubbles will burst before much longer. The result will likely be the destruction of trillions of dollars in asset wealth. This would throw the economy into a tailspin and wreak havoc on your retirement portfolio. Unfortunately the overwhelming majority of history is not on the Fed’s side as they try to prevent another recession and asset bubble popping by engineering a soft landing.
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