Could a soft landing still be possible for the economy?

Given the speed and magnitude of the Fed’s historic rate hiking cycle, investor concerns regarding a slowing economy and potential for recession have risen markedly. Nevertheless, there are notable bullish economic factors that suggest that growth remains solid, while also raising the potential that the Fed may need to respond by raising short-term policy rates even further than has been forecast to tame inflation.

The ISM Services Index, a measure that tracks the level of service activity across the economy, rebounded smartly into expansionary territory in January at 55.2. The surprising pickup was a sharp reversal from December’s modestly contractionary reading of 49.2. It was a particularly meaningful development since services drive close to 80% of U.S. GDP and cut across a broad swath of business sectors.

Another dominant driver of the U.S. economy is household consumption. Real personal consumption has continued to grow despite inflation cutting sharply into personal income in the past few years. Household financial conditions remain in reasonably good shape, despite the dwindling effects of stimulus programs, diminished savings, and increasing consumer borrowing. A resilient labor market that added 517,000 jobs in January and an unemployment rate at the lowest in a half century reinforce the strength of the U.S. consumer outlook. Consumer sentiment remains cautious but has been slowly improving over the past six months. That improvement was reinforced by a surprisingly strong retail sales report for January.

Bottom line? There’s a case to be made that the economy could skirt recession, though further Fed tightening will remain a headwind this year. Any soft landing will depend on consumer spending growth to continue as inflation recedes. So far, it’s happening.