Soft landing narrative hit by macro cracks
Investors, who have already fully embraced the soft landing narrative, might be putting themselves in a difficult position as the macro tailwinds begin to fade, according to ClearBridge Investments.
“Any tailwind from higher fiscal spending could be weakened or non-existent should government spending caps go into effect. The other lever to stave off a slowdown, monetary easing, also appears to be off the table as the Fed remains hamstrung by inflation and a tight labor market,” Jeff Schultze, director and head of economic and market strategy at ClearBridge Investments, said.
“We worry that many investors have fully embraced the soft landing narrative and are facing potentially the most dangerous part of this cycle’s climb with their guard down.”
He pointed to auto and credit card delinquency rates which were already above the peaks seen during the last economic expansion, and student loan delinquencies which were poised to rise as the repayment moratorium expired.
“Given the challenges consumers are facing, these strains could grow worse in the coming quarters,” he said.
According to Schultze, another crack was evident in the labour market itself. According to him, even though the economy continued to add jobs, every payroll release this year has been revised lower, and the preliminary benchmark revision last month reduced the March baseline by a further -306,000 jobs.
“Large downward revisions to the labor report have historically clustered around economic inflection points, with a similar streak of negative revisions occurring in 2007 in the run-up to the Global Financial Crisis. This data should not set off an immediate recession alarm, but rather is a sign that the labor market may be weaker than perceived,” he said.
“We believe the path of the labor market will determine whether the economy continues along the soft landing path or slips into recession,” he said.
Schultze also added that generationally high inflation and a tight labor market left the Fed hamstrung and likely slower to react to unfavourable data and more targeted when it does.
On top of that, a frozen Fed presented a significant risk to economic growth and could even allow what might have otherwise been a mild recession to metastasize into something worse.
“In summary, widening cracks across the economy and capital markets could short circuit the current rally. That path should become clearer in the coming quarters as we move through the crux.
“In the meantime, we continue to recommend tilts toward growth and defensive positioning until more clarity emerges on the economic path forward.”