The economy might seem to be improving, but it could just be the calm before the storm that is a possible recession.
It’s still far too early to celebrate a soft landing, according to well-known economist Gary Shilling. In fact, quite a few economic signs point to the fact the U.S. might still be headed toward a recession. As an economist, Shilling is known for a track record of accurate predictions stretching as far back as the 1960s—famously including the 2008 housing crash.
This time around, despite the unusual economic backdrop in which the Fed has been able to tame inflation without causing the unemployment rate to go up, Shilling says the very American tendency to believe in a rosy future overshadows some clear warning signs. “A lot of people are hoping that it’s a soft landing, but we Americans tend to be perennial optimists,” Shilling said during an interview on The Retirement Lifestyle Advocates radio show.
Shilling didn’t predict a recession. He did, however, point to the current trajectory of the labor market and the fact that historically interest rate hikes lead to recessions as evidence one was likely.
A soft landing hasn’t happened yet, either, Shilling points out. In order for a soft landing to have occurred, the Fed would need to raise interest rates and successfully lower them without pushing the U.S. into a recession. The only time that happened was in the 1990s. So far, he says, rates have gone up nearly a dozen times since the Fed started raising them in March 2022. But the Fed hasn’t started lowering them, meaning the process that would lead to a soft landing is still incomplete.
“It’s only when they then actually turn from tightness to ease that you can say they’ve effected a soft landing,” Shilling said.
The economy is still waiting for rate hikes to kick in
Interest rate hikes especially can be a reliable indicator of a possible recession, Shilling says. He’s far from alone in this theory. Many economists have pointed out recently that on average it takes just over two years—around 26 months—from when the Federal Reserve starts raising interest rates for the country to plunge into a recession. “Well, it’s been 24 months since they started raising rates,” Shilling said.
Top economists on Wall Street at banks like Morgan Stanley and Piper Sandler have echoed Shilling’s view. Morgan Stanley’s chief U.S. economist said a hard landing was a “guarantee.” While Piper Sandler’s chief economist Nancy Lazar also cautioned that the country was just now moving into the time frame in which a recession might be expected. All of these calls for a wait-and-see approach are in keeping with famed economist Milton Friedman’s concept of the “long and variable lag” that says the effects of monetary policy decisions often take extended periods of time to show up in the economy.
In the meantime, dampening the spirits of the soft-landing hopefuls was that Fed Chair Jerome Powell put off talk of interest rate cuts. Doing so would have signaled to the public that the Fed considered inflation under control. Only a few analysts thought Powell might do so as early as March. When Powell put the kibosh on the idea, it rattled their confidence. “Boy, that caused a momentary setback in the optimist views,” Shilling said.
Many of the firms that forecasted a March rate cut, like Goldman Sachs, revised their forecasts last month. Even if the Fed doesn’t lower rates in March, it is still planning for three cuts for the year. Though Powell was clear that he is waiting for signs confirming inflation stays low before doing so. “We want to see more evidence that inflation is moving sustainably down to 2%,” Powell told60 Minutes in February.
Shilling wasn’t surprised by the Fed’s delay. “The Fed is going to take their good, sweet time in cutting rates,” he said. “They want to make sure that inflation is back to their 2% target.”
A loosening, but still tight, labor market
Closely tied to inflation is the unemployment rate. Conventional wisdom has always dictated that to lower inflation the unemployment rate needs to rise. So far inflation has fallen from the highs of 2022 to a much more manageable 3.1% in January, without leading to spikes in unemployment.
Currently the labor market is still strong although not quite as frothy as it was during the height of the Great Resignation. Instead, workers are opting to stay put more than they were in recent years when they felt they could get a new job, with better wages relatively easily. Shilling believes the labor market will need to soften before the Fed starts lowering rates, which again will be the moment the country can definitively know whether the economy sticks the soft landing.
At one point in January 2023 a staggering 96% of people said they were looking for a job over the course of the year, according to a survey from jobs website Monster.com—although that trend has started to reverse, or at least revert back to the mean, with job switchers no longer earning the almost guaranteed 8.5% pay increases they netted in 2022.
In the meantime, businesses, too, are causing a tight labor market, according to Shilling. In his view many firms are reluctant to let people go after having fought so hard to recruit them during the historically competitive job market.
Because “you had so much tightness in labor markets earlier, all the hiring has created a mindset where businesses don’t want to turn around and fire people even though their sales and profits are soft,” Shilling said. “It takes time to shift gears 180 degrees, particularly after they had so much pain and expense and trouble hiring people. So that stretches it out.”
All that uncertainty, both in the job market and across the entirety of the economy, means consumers are slowly cutting back on spending. This, too, indicates a reversal of a long-standing trend that had stumped economists. The American consumer, whose spending accounts for some 70% of the U.S. economy, had proven to be extremely resilient. Now that’s starting to change, too, Shilling notes, which also portends changes to America’s economy. “If consumers switch from exuberance to caution, it makes a huge [impact on] the total economy,” Shilling says.
