As the “soft landing” narrative grows, the risk of a “crisis” event in the economy increases. Will the Fed trigger another crisis event? While unknown, the risk seems likely as the Fed’s “higher for longer” narrative is compromised by lagging economic data.
Such is a question worth asking as we look back at the Fed’s history of previous monetary actions. Such was a topic I discussed in “Investors Push Risk Bets.” To wit:
“With the entirety of the financial ecosystem more heavily levered than ever, the “instability of stability” is the most significant risk.
The ‘stability/instability paradox’ assumes all players are rational and implies avoidance of destruction. In other words, all players will act rationally, and no one will push ‘the big red button.’
The Fed is highly dependent on this assumption. After more than 13-years of the most unprecedented monetary policy program in U.S. history, they are attempting to navigate the risks built up in the system.“
Historically, when the Fed hikes interest rates and yield curves invert, someone inevitability pushes the “big red button.”
But that is also the fallacy in the 1995 “soft landing” scenario the media is currently pinning its hopes on. Indeed, the economy did not slip into a recession; however, there were crisis events along the way. More importantly, the yield curve did not invert in 1995. However, it inverted in 1998, and a recession followed roughly 24 months later.
The chart above shows that yield curve inversions occur roughly 10-24 months before recognizing a recession or crisis event. This is because it takes time for the “lag effect” of higher borrowing costs to negatively impact the economy.