Early in 2023, the consensus view was that a global recession was coming later in 2023. But as the year has matured, the consensus outlook has completely shifted. A soft landing—or even no landing—is now the consensus. What is remarkable is how strong the consensus has become. The consensus is, indeed, so consensus!

I think differently. A soft landing is merely a convenient and comfortable fairy tale, backfitted to match the market prevailing narrative and based on backward-looking unique circumstances. A hard landing is coming—it’s just a matter of when.

The US Consumer Price Index (CPI) has trended steadily lower since peaking at 8.93% in June 2022. Despite higher readings in July and August 2023, core CPI—which excludes the volatile food and energy categories—has continued to decline. This has led to some speculation that the Federal Reserve could soon switch from raising interest rates to cutting them. 

CPI data are reported on a year-over-year basis to help limit seasonal effects and the impact of short-term events that may prove temporary. While these readings have been encouraging, shorter‑term trends that typically offer more information about the current state of inflation are concerning. The three-month CPI moving average from July to August rose from 1.90% to 3.98% (Figure 1)


Peak Everything: What Goes Up Must Come Down

But the temporary benefits of looser financial conditions and US fiscal spending will soon wear off. In fact, I worry that we might have reached “peak everything” in that all factors that have contributed to the global economy’s resilience have now turned.

• Peak fiscal
• Peak inflation
• Peak liquidity
• Peak China growth
• Peak housing
• Peak credit
• Peak employment

Aggressive Tightening, Leverage Set Stage for Hard Landing

It already appears that global manufacturing is flashing signals of being in a recession. The Covid-induced boom in the services sector is showing signs that it is also past the peak. Labor markets are not as strong as they were.

Most importantly, when global economic activity indicators were around current levels in past economic cycles, central banks were already well into rate-cutting mode. But this time around, we have central banks still tightening while also winding down their balance sheets through quantitative tightening. Global central bankers appear to have calibrated monetary policy to a world where the extreme tailwinds coming out of the pandemic—the spending boom driven by Covid-induced saving as well as the services-led recovery—continue well into the future.

The Fed has hiked the federal funds rate by more than 500 basis points (bp) since kicking off the tightening cycle in March 2022, and it currently looks like it could increase rates once more in 2023. The European Central Bank has tightened by over 400 bp and the Bank of England by more than 500 bp. Even the Bank of Japan, which has faced
much lower inflation than in other developed markets, has widened its target range for government bond yields to let them increase.

As central bankers remind us, monetary policy works with long and variable lags. The cumulative global tightening is massive. This will eventually become the dominant narrative instead of the current market consensus’s focus on the warm glow of the recent one-offs.

Making matters worse, all the conditions for a hard landing are present. Leverage in pockets of the financial system seems to be rising, and we know from past experience that elevated leverage can quickly cause cracks to become craters. And we’ve already seen some cracks—regional bank liquidity problems in the US as well as severe stresses in China’s property sector and UK pension funds. I fear that the next one may be a crater.

Leverage is now likely in different places than during the global financial crisis. We have seen large-scale disintermediation of the banking system into less well-regulated and more opaque areas. This just means that the vulnerabilities may play out in different areas than in the past.

Market Pricing in Soft Landing Is Unrealistic

The other area where leverage has increased is on government balance sheets. During Covid, there was a large scale transfer of leverage from the private sector to the public sector. This has a few consequences. First, fiscal balances are now largely tapped out. When the recession comes, it will be hard for governments to spend their way out.

Second, global governments need to sell a ton of new bonds. Recently, a lot of issuance has been in the Treasury bill market, but as we move into 2024, much of these bills will need to be termed out and replaced with longer-maturity debt.  

Who will buy all this duration,4 especially at a time when central banks are stepping back from bond purchases? The implication is higher long-term bond yields. So while eventually central banks will respond belatedly to recession with rate cuts, there is the potential that the calming power of those official rate cuts may be offset by a lack of response in longer yields. A late, blunted, and incomplete response could lead to a deeper and longer malaise.   

A soft landing is consensus. In the near term, China’s stimulus and potentially a build in inventories may prolong the good mood. But a hard landing is much more likely in the longer term. The only questions are when those long and variable monetary policy lags will show their inevitable dominance and how to navigate that journey.