Key points for a possible soft landing

Due to the resilient performance observed so far this year, there is a growing perception in the market that the economy may be heading towards what is commonly referred to as a “soft landing.” In broad terms, this concept pertains to the implementation of a restrictive monetary policy by the Federal Reserve (involving high-interest rates and a withdrawal of liquidity) without causing a severe impact on employment generation and avoiding negative GDP growth. In this context, we present some key points supporting this view:
- Economic growth. GDP performance has consistently exceeded its long-term trend since the third quarter of 2022. According to the consensus, the GDP for the third quarter of 2023 is estimated to have expanded by an annualized 4.5% (compared to 2.1% in the second quarter of 2023). Notably, job growth turned out to be stronger than anticipated during this period, with an average of 266,000 new jobs created each month. A robust labor market, along with a slowdown in inflation, suggests that consumer spending is less vulnerable than previously thought. This holds true even though a significant portion of the savings accumulated during pandemic-related stimulus measures has already been spent.
- Inflation. Core inflation, which excludes food and energy prices, has been decreasing in recent months despite robust economic growth. The core inflation rate of 4.1% recorded in September was the lowest in two years. Core goods inflation reached zero, implying that all inflation was driven by services, with shelter being the most significant contributor. When excluding this component, both core and headline inflation remained at moderate levels around 2%. Data related to new rental agreements indicates that housing inflation, which typically lags new agreements by approximately 12 months, may slow down in the coming months, eventually leading to a more significant reduction in headline inflation.
- Monetary Policy. Projections from the Federal Reserve’s September meeting showed that the majority of participants anticipate a further increase in interest rates by the end of 2023. Given robust job growth and inflation that, although decelerating, remains above the Federal Reserve’s target, the question arises: why not raise interest rates? One factor that might make a further increase less likely is the substantial adjustment in long-term bond yields (the yield on the 10-year bond has risen so sharply that it now trades above 5%, a level not seen since July 2007). There is a strong consensus that rates are well above neutral, suggesting that inflation will eventually return to its target if the Federal Reserve simply maintains rates at their current levels. Considering the uncertainty surrounding future economic conditions, it is believed that the Federal Reserve may opt to keep rates unchanged and monitor the evolution of new economic and financial data.
Growth has been above trend since the third quarter of 2022

Note: The graph shows GDP performance at annualized quarter-over-quarter rate and annual change (%).
Source: UBS