Every pilot undertaking a liftoff is hoping, planning and promising that the flight will end in a soft landing. So it is with Federal Reserve Chair Jerome Powell, who started the liftoff of a rate-hiking campaign this month citing specific soft economic landings in prior cycles as a guide to the current tightening campaign. Financial markets, so far, seem tentatively to believe this is a plausible outcome — a succession of moves that pulls short-term interest rates up toward or a bit above the "neutral level," restraining inflation and moderating economic growth without dropping the economy into a hard landing, or recession. The S & P 500 is up almost 10% from its recent low from the days before the Fed lifted rates a quarter-percent on March 16, and 6% of that gain has come since Powell began explaining the rationale and the Fed's outlook at his post-meeting press conference. The CBOE S & P 500 Volatility Index has sunk from an agitated 29 to a more normal 22 and high-yield corporate bond spreads have tightened up. This improvement in risk sentiment amount to an implicit endorsement of the economy's ability to handle higher rates for a while. It also amounts to a loosening of financial conditions — even as the 10-year Treasury yield has jumped from 2.18% to 2.5% and the two-year yield , a closer proxy for anticipated rate hikes, has surged from 1.97% to 2.3%. Today vs. 1994 Powell cited soft landings in 1965, 1984 and 1994 in support of his case that one could be achieved again. For a few reasons, the 1994 tightening cycle has become the key touchstone. (In the '60s it was a more elongated rate-normalization effort that began a couple years before 1965; in the '80s the economy had come off back-to-back recessions and the Fed had to quickly cut rates far more than it had just raised them to avoid recession.) But in 1994, an economy starting to run hot was met with three percentage points of rate hikes from Alan Greenspan over the course of a year, forestalling a threatening rise in inflation even as unemployment continued to fall and corporate profits grew nicely. For markets, it was a trying, anxious year, with a genuine bond-market crash and a choppy, corrective, rangebound equity tape that ultimate emerged less expensive and primed for a massive leg higher in 1995. Treasury yields soared from 6% at the time of the initial February 1994 to 8% by the end of the year. The Treasury yield curve from two- to 10-year maturities flattened severely but never quite inverted (inversion being a very rough, not very timely precursor to recessions). Massive losses were absorbed by fixed-income players running with leveraged bets on persistent low rates, as closed-end bond funds blew up, the securities-brokerage industry as a whole lost money for the year and Orange County, Calif., went bankrupt on bad investment-fund rate bets. As for stocks, the S & P 500 rushed to near-10% correction, then was rangebound, while small-caps fared worse. Jon Turek, a macro strategist at JST Advisors, plots the current S & P 500 path over that of 1994-'95 to find similar contours so far. Equity valuations were under heavy pressure all year in 1994, from relatively modest levels to start with. The S & P 500 went from 15-times forecast 12-month earnings down to about 12-times that year. Currently, the S & P multiple is likewise receding, though from a richer starting point, slipping from 22.7 last April to 19.6 now, having dipped almost to 18 at the recent market lows. Key differences There is plenty that rhymes with 1994 today, then, but it's far from a near rerun. For one thing, the Fed back then was acting in an intentionally and aggressively pre-emptive way to restrain an economy at much higher levels of unemployment and before inflation began galloping. The unemployment rate was well above 6% when the Fed began tightening, compared with 3.8% now. Back then, the Fed itself estimated that 6.5% was the Non-Inflationary Rate of Unemployment," below which further job gains would be unwelcome from a price-stability standpoint. Joblessness kept falling for years to undermine this notion, but it meant there was a lot of slack in the labor market the Fed wasn't giving it credit for. Turek notes that in '94, after three quarter-point hikes and one half-point bump, the Fed stood pat for three meetings as policymakers assessed the impact. The markets today seem to leave open the chance that something similar happens now – a front-loaded bout of hikes, then a wait to see if inflation breaks lower. It's crucial, too, that 1994 was the very dawn of Fed policy transparency; the February rate-hike meeting that year was in fact the very first time the Fed had ever even announced a change in the target Federal funds rate. Before that, the market simply had to figure it out based on the Fed's own open-market operations. Today, the Fed has spent four months aggressively steering investor expectations to more aggressive tightening intentions. Arguably this has moved the markets a fair distance toward the pricing in of the tightening campaign – the S & P 500 at the same level it reached seven months ago, having pulled back 13%, bonds pricing in at least 1.5 percentage points more tightening already. Another difference: This Fed came into the current inflationary episode openly refusing to act pre-emptively against inflation. And, needless to say, inflation has run far ahead of anything seen in 1994, when the CPI was 3%. In fact, less than four years ago, in 2018, Powell gave a speech admiring of a wholly different phase of Greenspan's 1990s Fed leadership – the willingness in the late '90s to allow unemployment to keep falling without rushing to lift rates, as Greenspan saw a productivity surge in a newly technology-driven economy that was keeping inflation from becoming a problem. In other words, Powell has gone from modeling himself on the dovish, hands-off late-'90s Fed to trying to find cover for his current hawkishness in the well-turned 1994 tightening phase. Perhaps this is just about a Fed that is going to do as much as it can to get rates to a more normal spot, while using whatever rationale works in the moment? Soft landing doubters There is plenty of skepticism that a "perfect soft landing" — as former Fed governor Alan Blinder called 1994 — is the leading likelihood now. Roberto Perli, head of global policy research at Piper Sandler, says after reviewing the prior soft-landing episodes: "Bottom line: 61 years of data, 8 recessions. All of them associated with Fed tightening in the vicinity of or above neutral. Only one clear exception to the rule (1994). The market seems justified in seeing increased risk of recession." Bonds already foresee rate cuts starting in 2023 into 2024, though that, in itself, doesn't mean a recession would have set in. For sure, there's a chance that we are in a regime in which risk-asset rallies simply open up more daylight for the Fed to tighten more or sooner, a shift from the days when stock-market selloffs were a prompt for the Fed to stay easier for longer. This interplay could indeed cap market rallies and create a bumpier path – somewhat like 1994. And don't overlook the chance for capital-markets accidents like the fixed-income fiascos of 1994. It could be simpler than all this – the potential for recession, such as it is, is far enough off that an oversold stock market was able to recover half its correction losses as corporate profit estimates hold up. And real, inflation-adjusted yields remain well below zero, another difference versus 1994, which by some lights is another buffer for equities.
Traders on the floor of the NYSE, March 25, 2022.
Every pilot undertaking a liftoff is hoping, planning and promising that the flight will end in a soft landing.