Ed Yardeni sees four economic outcomes, with one being the most likely

Published Tue, Feb 21 20231:33 PM EST

The economy faces four potential outcomes, with the most optimistic also being the most likely, according to market veteran Ed Yardeni. Faced with elevated inflation , weak corporate profits and rising interest rates, the U.S. is still in a good position — 40% probability — to manage a "soft landing," in which GDP nudges higher, inflation decelerates to about 3%-4% and interest rates stay in check, the head of Yardeni Research wrote overnight Monday. In that scenario, bond yields also moderate, and the stock market gets a nice boost even after a fast start to 2023. Other potential outcomes and their percentages, according to Yardeni: a disinflationary no landing (20%), hard landing (20%), and inflationary no landing (20%). "The first two scenarios add up to a 60% subjective probability, in our opinion. They are optimistic outlooks for the economy and bullish for stocks and bonds," Yardeni wrote. "The second two scenarios add up to 40% subjective probabilities, in our opinion. They are pessimistic outlooks for the economy and bearish for stocks." The forecast follows a January in which economic data reflected continuing strength, particularly in the labor market , coupled with higher-than-expected monthly inflation readings that nonetheless showed prices decelerating on an annual basis. Federal Reserve officials are watching the data closely; markets now expect a more aggressive central bank, with another 0.75 percentage point worth of interest rate increases ahead. That prospect has rattled markets in recent days, though the S & P 500 is still up more than 4% year to date. Though Yardeni is optimistic, many economists still think the U.S. is headed for recession. "If that happens, it will be the most widely anticipated recession of all times," he said. "Hard-landers keep pushing it out as their dire predictions don't pan out, especially now that the no-landing scenario has made a surprising comeback as a result of January's stronger-than-expected economic indicators." The disinflationary no landing scenario entails real GDP rising 2%-3% while inflation moderates. On the downside, that would mean a more aggressive Fed, which could take its benchmark funds rate to a range of 5.5%-5.75%, a quarter percentage point higher than current market expectations. A hard landing, according to Yardeni, would see an outright recession, something the economy likely skirted in the early part of 2022 despite posting consecutive negative GDP readings. Finally, the inflationary no landing scenario would see the economy avoid recession but still be plagued by high prices, resulting in a more hardline Fed. "This may be the most bearish scenario of them all because Fed officials would have to raise interest rates much higher as they conclude that only a recession can bring inflation down," Yardeni said. "In other words, the inflationary version of the no-landing scenario would simply be the long way to a hard landing, resulting in an even deeper recession and more bearish outlook for stocks." Markets will get a better look at where the Fed stands when it meets again March 21-22. While the rate-setting Federal Open Market Committee is widely expected to hike at least a quarter point, investors may be more focused on where officials take their economic forecasts. Committee members will update their outlooks on GDP, inflation, unemployment and the future path of the funds rate. In recent days, officials have said they are encouraged by the progress on inflation but remain vigilant.