Odds of a Hard Landing Are Increasing

Key Points

  • Although the Fed is unlikely to raise rates in June, the reprieve will probably be short-lived. Damage has been done, and the expected further hikes mean more damage. The recession we are imminently facing is self-inflicted.

  • The inverted yield curve is responsible for two causal channels to this recession: 1) the self-fulfilling prophesy of its successful track record as a recessionary signal, and 2) the inversion’s magnitude, which is putting high levels of stress on the US banking and financial systems.

  • Two negatives—the Fed’s mistaken characterization of inflation as transitory, and the Fed’s failure to pause rate hikes in early 2023 amid signs of moderating inflation—do not make a positive. The result is a banking and financial system, as well as a commercial real estate market, under stress. As a result, the odds of a hard landing have increased.

Since January 4, 2023, I have argued that the Fed has been aggressively raising short rates to compensate for its earlier mistake of being late to realize that inflation was not temporary. Continuing to raise rates placed the Fed in danger of overshooting—increasing rates well beyond when it should have stopped—and jeopardizing the chance to achieve a soft landing. After the failures of Silicon Valley Bank (SVB) and two other large banks in the early spring, the Fed was in a lose–lose situation: a pause in rate hikes could be interpreted as a sign of a fragile banking system and lead to panic, whereas another hike would intensify stress on the financial system. On May 3, the Fed chose the latter option, hiking another 25 basis points (bps). That action and the previous hike heightened the likelihood of a hard-landing recession.