#inflation

How Soft – or Hard – Could the Landing Be?

As the chance of recession comes down to the balance of moderating inflation vs. a slowing economy, we should also ask how much stress the economy can absorb.

If a 2023 recession is avoided, it will be because U.S. consumers and firms are still in robust health. Household balance sheets are strong, and the labor market is booming. Encouragingly, we see some cooling of inflation pressures (such as falling durable goods prices and easing wage growth) without macroeconomic weakness. And though firms’ margins will decline from here, they’re coming down from exceedingly strong levels.

Yet, it’s easy to point to the economy’s vulnerabilities. Deteriorating business sentiment can weigh on investment rapidly, robbing the economy of momentum. And despite the strong labor market and strong household balance sheets, consumer confidence has been depressed for a while, likely driven by energy prices. Add to that the fact that wobbly financial markets shrink household wealth — a problem that would get bigger if the housing market were to turn — and the cycle looks vulnerable.

That said, if a recession hits in 2023, there are good reasons to expect it to be mild because the drivers of the most damaging types of recession are less likely today. Banks are well capitalized, profitable, and unlikely to drive a structural overhang in recession. This leaves the prospect that demand could return quickly and that labor markets remain tight, which would keep a recession mild.