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Part II: Quantifying Episodes of Soft-Landing, Stagflation and Recessions

Summary

• In the second part of the series, we quantify episodes of soft-landings, stagflation and recessions during the post-1950 period.
• To the best of our knowledge, we are the first to present a framework to quantify periods of soft-landing for the U.S. economy.
• Our work estimates that there are 13 episodes of stagflation and 13 episodes of soft-landings in the post-1950 era.
• According to the NBER, there are 11 recessions during the same period.
• In the next installment of the series, we'll introduce a probit framework to generate four-quarter-out probabilities of the three scenarios. These probabilities would be helpful to determine the magnitude and duration of upcoming policies, as monetary policy decisions are influenced by the near future economic outlook.

Soft-Landing, Stagflation and Recessions: The Three Potential Drivers of Monetary Policy Stances

The first part of the series introduced our framework to characterize the U.S. economic outlook into three regimes: recession, soft-landing and stagflation. As we discussed in Part I, we divide the economy into three regimes because they are structurally different and thus lead to different monetary policy stances, all else equal. For example, a recession forecast would dictate an accommodative policy stance (as seen in the past four recessions), while a stagflation prediction would require policy tightening, seen in the 1980s recessions.

To the best of our knowledge, we are the first to develop a framework to quantify periods of soft-landings for the U.S. economy. In a series published earlier this year, we estimated that there were 13 episodes of stagflation taking place in the post-1950 period, five of which were mild, four that were moderate and four that were severe. According to the National Bureau of Economic Research (NBER), there have been 11 recessions since 1950. Using these historical episodes, an analyst can build a framework to generate the probability of each scenario occurring in the near-term. Knowing these probabilities could help shine light on the potential path of monetary policy.

Quantifying Episodes of Soft-Landings: A New Approach

In our approach, we assume that a period of weak economic growth would ask for accommodative monetary policy to jump-start the economy, while strong growth may require contractionary policy to avoid overheating, all else equal. A trend-like growth period (a Goldilocks economy, for example) may be neutral ground for monetary policy. Thus, we define a soft-landing as a trend-like growth period.

We utilize Congressional Budget Office's (CBO) potential real GDP series for the U.S. economy (Figure 1) as a benchmark to identify periods of soft-landings. Additionally, we use the real GDP growth rate as a measure of the economy's output (Figure 2). In our approach, we compare the magnitude and duration of actual output growth with CBO's projections of real GDP.

We employ a time-varying approach to capture the evolving nature of the economy. In the first stage, we utilize NBER business cycle dates to divide CBO's potential real GDP growth rates into periods of recession and expansion. In the second stage, we characterize each expansion period into episodes of weak or strong soft-landings using the mean and standard deviation of the previous expansion as a baseline. In a real-time analysis, we would only know the past and present data, so we compare the current period's growth rate with the previous business cycle expansion's average value to judge whether it is a weak or strong soft-landing.

There are 12 expansions in our sample of the post-1950 period. We calculated the average growth rates along with the standard deviations and stability ratios (the standard deviation as a percent of the mean) for each of those 12 expansions. The results are displayed in Table 1.1 The expansion following the 1948–1949 recession had the strongest average potential growth rate, with a value of 5.4%. The weakest expansion in our analysis was the expansion following the Great Recession, with a 1.8% average potential growth rate.

To determine whether the expansion was a weak or strong soft-landing, we multiplied the standard deviation of the previous expansion by two and then added and subtracted that from the previous expansion's average growth rate to determine a threshold. For example, when determining the threshold for the expansionary period after the pandemic, we multiplied the standard deviation of the post-Great Recession expansionary period by two and added and subtracted that by its average potential growth rate. The calculated range would therefore be 1.4%–2.2%. So, if real GDP growth in the post-pandemic recessionary period stayed in between 1.4% and 2.2%, it would be considered trend-like growth. If it exceeded the upper limit of 2.2%, it would be characterized as strong growth. Likewise, if it fell under the lower limit of 1.4%, it would be characterized as weak growth.2 (Table 1)

To determine the duration component of our approach, we followed the “technical recession” definition of two consecutive quarters of negative real GDP growth and set a minimum duration of two consecutive quarters of real GDP growth rates that stay within the threshold (i.e., the mean +/- two standard deviations) to classify an episode of soft-landing. Sticking with two consecutive quarters as a minimum threshold helps to remove noise from the data and provides more useful signals, in our view. For example, in our analysis, the first episode of soft-landing is for the Q1:1963–Q2:1963 period, as two consecutive quarters of real GDP growth rates stayed within the range of 3.4%–4.6% (the GDP growth rates were 3.6% and 3.8% for Q1 and Q2 1963, respectively).

Based on these criteria, our framework estimated that there are 13 episodes of soft-landings in the post-1950 era (Table 2). The longest duration of any soft-landing period was eight quarters, which occurred during Q4:1984–Q3:1986, and five episodes shared the shortest duration of two quarters. According to our analysis, the last episode of soft-landing lasted only two quarters and ended in Q2–2023. Since the last episode of soft-landing, GDP growth rates have stayed above the upper-limit of the threshold most of the time (Appendix).

Testing, Not Assuming, Would Be a Better Way To Project the Near-Term Policy Path

Rather than assuming that the FOMC may repeat the past easing cycle's behavior, we suggest that predicting the potential growth scenarios is a better path, as it is more consistent with the FOMC's mantra of “data-dependent decision-making.”

We believe NBER’s recession dates methodology and our approach of soft-landing episodes are valuable inputs to policy decisions, as they capture the recession risk and the soft-landing scenario. Including our stagflation work in the mix would complete the three major economic scenarios for monetary policy decision-making. In the next installment of the series, we'll introduce a probit framework to generate four-quarter-out probabilities of the three scenarios. By predicting the near-term likely growth scenario, the probit framework could be a valuable input to project the possible path of the upcoming easing cycle.

Endnotes

1 – We employ the compound annual growth rate (CAGR) of both potential and actual real GDP. The CAGR form is a widely utilized gauge of the current run-rate of the economy. For example, when NBER determines U.S. business cycle dates, it uses the CAGR transformation of real GDP, in addition to other variables, to determine a given recession’s peak and trough.

2 – We employed two S.D. plus/minus the mean to establish upper and lower limits of our threshold to determine periods of soft-landings. We followed the so-called “Three-Sigma” rule where mean plus and minus two S.D. would capture about 95% of the data series—i.e. the statistical confidence level would be 95%. For more detail about the Three-Sigma rule, see Huber, Franz. 2018. A Logical Introduction to Probability and Induction. New York: Oxford University Press, 2018.

Appendix

As a robustness check to our proposed framework, we explore alternatives to our employed benchmark of CBO’s potential real GDP series. One alternative could be the real GDP growth rate akin to NBER’s recession approach that heavily relies on real GDP in addition to several other variables. We provide mean, standard deviation and stability ratios based on real GDP (CAGR) for each expansion since 1950, like in Table 1. The largest mean is 8.1% for the 1950–1953 expansion, and the lowest average value of 2.4% is associated with the post-Great Recession era. The stability ratio column indicates that the series is very volatile, as the smallest value is 48 (the S.D. is about half of the average value) for the 1991–2000 expansion. Moreover, the two S.D. rule would be misleading, as the smallest two S.D. is 3.2% (for the post-Great Recession era), which would create a wide range of -0.8% and +5.6% and declare the entire post-Great Recession era as a soft-landing. Therefore, we stick to CBO’s potential real GDP as a benchmark to identify soft-landing episodes.

Markets

July US CPI inflation figures printed very close to consensus. Monthly inflation accelerated both on a headline and on a core level to 0.2% M/M. Details showed food prices rising by 0.2% M/M, energy prices flat, and services (ex. energy) rising by 0.3% M/M. The main disinflationary impact came again from used cars and trucks where prices dropped by 2.3%. Shelter costs remain sticky at 0.4% M/M. Y/Y-inflation nudged slightly lower on the top (2.9% from 3%) and on the underlying level (3.2% from 3.3%). Supercore services inflation (stripping out food, energy, goods and shelter costs) accelerated to 0.2% M/M after two months of decline (4.5% Y/Y). Today’s dull set of data strengthens Powell’s case to start cutting the policy rate at the September meeting, but doesn’t settle the debate on the magnitude of such first cut. US money markets take some chips off the table after pushing the probability of a 50 bps move to over 60% in the wake of yesterday’s benign CPI’s. The next reference is next week’s Jackson Hole Fed symposium (Thursday – Friday). Based on data published since the July 31st FOMC meeting, we don’t expect Powell to already pre-commit to one thing or the other. Early September activity and labour market data are the ones to watch in this respect. US yields today rebound up to 4 bps at the front end of the curve (2-yr). The slight underperformance against Germany (+2 bps) doesn’t really help out the dollar. EUR/USD pierced the psychologic 1.10 barrier already early today and at 1.1035 sticks with its gains. The December 2023 top at EUR/USD 1.1139 remains the next reference with the dollar unable to comeback as long as the market plays with 50 bps Fed rate cut idea. US stock markets open marginally positive (+0.2%).

Headline UK CPI fell by 0.2% M/M (vs -0.1% M/M) with the annual figure rising to 2.2% from 2% (vs 2.3% forecast). Core CPI slowed to 0.1% M/M and 3.3% Y/Y (from 3.5% Y/Y). The more benign inflation print suggests the BoE’s close call to cut its policy rate by 25 bps early August was the right one with follow-up action becoming very likely. UK Gilts outperform with the belly of the curve dropping over 6 bps. EUR/GBP spikes from 0.8540 to 0.8590.

News & Views

Swedish headline inflation rose by 0.1% M/M in July on the headline level with the Y/Y-figure stabilizing at 2.6%. Housing costs continue to be the largest contributor as well as rising fees for rented and tenant-owned appartments. The higher housing costs were partly offset by lower electricity prices. The inflation rate according to the Swedish Riksbank’s preferred CPIF (Consumer Price Index with fixed interest rate) was 1.7% Y/Y (+0.1% M/M), up from 1.3% in June. That’s below the central bank’s 1.8% forecast and suggests that they will able to put their words (two to three extra rate cuts by year-end) into action. They meet next on August 20 with money markets completely discounting a 25 bps rate cut and even contemplating the possibility of a larger (50 bps) cut. The Swedish krone didn’t respond to today’s data which were broadly in line with consensus. EUR/SEK currently changes hands just below 11.50.

The chairman of the world’s largest steel company, Baowu Steel Group, said the sector now faced a crisis more acute than the downturns of 2008 and 2015, likening the conditions to a “severe winter” and highlighting a need to preserve cash. A weakening of China’s property sector, fading hope on significant stimulus and the treat of a US recession all have their impact. YTD output lags last year’s pace at Chinese mills with key product prices collapsing. Iron ore futures fell to $95.2 a ton, the lowest level since May last year.

Graphs

EUR/USD: heading to 1.1139 resistance

EUR/GBP: benign CPI print triggers Gilt outperformance and pullback in sterling

EUR/SEK: Swedish krone unmoved by CPI data

US 2-yr yield: no additional 50 bps rate cut bets after “dull” US CPI print

• Gold moves sideways; faces resistance near 2,473
• Technical signals are positive for a continuation to 2,500 ahead of CPI data

Gold repeated its July bounce off the 200-period simple moving average (SMA) on the four-hour chart to re-examine the 2,473 resistance, which ceased upside pressures earlier this month.

The bulls have been unsuccessful so far as the battle against the 2,473 barrier continues for the third consecutive day. That said, the technical picture keeps feeding optimism for a positive continuation into the uncharted territory, at least towards the 2,490-2,500 area.

Despite losing some ground, the RSI is still well above its 50 neutral mark, whilst the stochastic oscillator seems ready for another upturn. In other encouraging signs, the 20- and 50-period SMAs have posted a bullish cross, endorsing the latest upside reversal in the price too.

Above the 2,500 number, which overlaps with the almost flat resistance line from April 2024, the spotlight might turn to the 161.8% Fibonacci extension of the previous downleg at 2,550.  The 2,611 level could be the next challenge ahead of the 261.8% Fibonacci of 2,660.

In the event the price terminates its ongoing consolidation phase below its 20-period SMA at 2,453, it may dive into the 2,435-2,420 zone, where the 50-period SMA is located. Then, the door would again open for the 200-period SMA and the support trendline from February 2024 at 2,400. If that floor collapses this time, selling interest could intensify towards the 2,355-2,380 region.

Summing up, gold is again testing the critical resistance of 2,470, a break of which is expected to chart a new record high, likely within the 2,490-2,500 area. Otherwise, a pullback below 2,453 could result in additional declines. 

The Consumer Price Index (CPI) rose 0.2% month-on-month (m/m) in July, bang-on the consensus forecast. On a twelve-month basis, CPI fell to 2.9% (from 3.0% in June).

• After exerting a measurable drag in each of the two prior months, energy prices were largely flat in July. Food prices matched last month's gain, rising 0.2%.

Excluding food and energy, core prices rose 0.2% m/m, a modest acceleration from June's very soft monthly gain of 0.06%. The twelve-month change on core slipped by a tenth of a percentage point to 3.2% – the slowest pace of growth in over three years – while the three-month annualized rate of change fell to 1.6%.

Core services advanced a bit faster in July, rising by 0.3% m/m, and were entirely responsible for the uptick in headline inflation.

• Shelter costs ticked higher by 0.4%, or roughly double the pace of growth seen in June and accounted for 90% of the monthly gain in headline CPI. Last month's uptick in shelter costs were roughly in-line with the monthly gains averaged over the past twelve-months.
• Meanwhile, non-housing service inflation (aka 'supercore') rose by a soft 0.2% (0.15% unrounded) – an acceleration from last month's modest pullback – thanks to an uptick in motor vehicle insurance (+1.2%), recreational services (+0.4%) and 'other' personal services (+0.3%).

Core goods prices fell by 0.3% on the month, largely due to a further decline in new (-0.2%) and used vehicle prices (-2.3%). Goods prices have been flat or have registered a decline in each of the last 14 months.

The British pound is showing limited movement on Wednesday. GBP/USD is trading at 1.2844 in the European session, down 0.15% on the day.

UK inflation report supports case for September rate cut

Headline inflation in the UK rose 2.2% y/y in July, up from 2% in June but below the market estimate of 2.3%. Perhaps most important for the Bank of England, services inflation slowed to 5.2%, the lowest since June 2022 and well below the BoE’s forecast of 5.6%. Monthly, inflation fell 0.2% in July, down from 0.1% in June and the first decline in six months. Core inflation fell from 3.5% y/y to 3.3% and monthly from 0.2% to 0.1%, also below expectations.

The soft inflation report supports the case for another rate cut in September, which the money markets have priced in at 45%. The BoE joined the new phase of the central banking cycle when it cut rates on August 1 by a quarter-point to 5%. The BoE meets next on September 19.

The UK released a mixed employment report on Tuesday. The unemployment rate dipped to 4.2% in the second quarter, down from 4.4% in Q1 and wage growth with bonuses slowed from a revised 5.8% y/y to 5.4%, its lowest level in two years. Still, this was much higher than the market estimate of 4.6% and is much higher than the inflation rate. Unemployment claims shot up to 135 thousand in July, blowing past the market estimate of revised 36.2 thousand and the market estimate of 4.6%.

GBP/USD Technical

•  There is resistance at 1.2833 and 1.2903
•  1.2792 and 1.2722 are the next support levels

AUD/USD is consolidating gains near the 0.6620 zone. NZD/USD is trimming gains and struggling to stay above the 0.6000 pivot zone.

Important Takeaways for AUD/USD and NZD/USD Analysis Today

• The Aussie Dollar started a downside correction from 0.6640 against the US Dollar.
• There is a key bullish trend line forming with support at 0.6610 on the hourly chart of AUD/USD at FXOpen.
•  NZD/USD is declining from the 0.6080 resistance zone.
• There is a major bullish trend line forming with support at 0.6010 on the hourly chart of NZD/USD at FXOpen.

AUD/USD Technical Analysis

On the hourly chart of AUD/USD at FXOpen, the pair started a fresh increase from the 0.6500 support. The Aussie Dollar was able to clear the 0.6580 resistance to move into a positive zone against the US Dollar.

There was a close above the 0.6600 resistance and the 50-hour simple moving average. Finally, the pair tested the 0.6640 zone. A high was formed near 0.6642 and the pair is now correcting gains.

There was a move below the 0.6630 level. The pair declined below the 23.6% Fib retracement level of the upward move from the 0.6579 swing low to the 0.6642 high. On the downside, initial support is near a key bullish trend line at 0.6610.

The next major support is near the 61.8% Fib retracement level of the upward move from the 0.6579 swing low to the 0.6642 high at 0.6600.

If there is a downside break below the 0.6600 support, the pair could extend its decline toward the 0.6580 level. Any more losses might signal a move toward 0.6545.

On the upside, the AUD/USD chart indicates that the pair is now facing resistance near 0.6640. The first major resistance might be 0.6650. An upside break above the 0.6650 resistance might send the pair further higher.

The next major resistance is near the 0.6700 level. Any more gains could clear the path for a move toward the 0.6740 resistance zone.

NZD/USD Technical Analysis

On the hourly chart of NZD/USD on FXOpen, the pair started a steady increase from the 0.6000 zone. The New Zealand Dollar broke the 0.6035 resistance to start the recent increase against the US Dollar.

The pair climbed above 0.6060 and the 50-hour simple moving average. It tested the 0.6080 zone and is currently correcting gains. The pair corrected lower below the 0.6060 level. The pair also traded below the 50% Fib retracement level of the upward wave from the 0.5988 swing low to the 0.6081 high.

The NZD/USD chart suggests that the RSI is now well below 50 and signaling more downsides. On the downside, there is major support forming near 0.6010 and a trend line.

The trend line is close to the 76.4% Fib retracement level of the upward wave from the 0.5988 swing low to the 0.6081 high. The next major support is near the 0.5990 level.

If there is a downside break below the 0.5990 support, the pair might slide toward the 0.5980 support. Any more losses could lead NZD/USD in a bearish zone to 0.5950.

On the upside, the pair might struggle near 0.6035. The next major resistance is near the 0.6060 level. A clear move above the 0.6060 level might even push the pair toward the 0.6080 level. Any more gains might clear the path for a move toward the 0.6200 resistance zone in the coming days.

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Daily Pivots: (S1) 146.31; (P) 147.13; (R1) 147.66; More...

No change in USD/JPY's outlook and intraday bias stays neutral. Outlook stays bearish with 38.2% retracement of 161.94 to 141.67 at 149.41 intact and intraday bias stays neutral. Below 145.42 minor support will turn bias to the downside for 141.67. Break there will resume the fall from 161.94 to 140.25 support next. Nevertheless, decisive break of 149.41 will bring stronger rally to 61.8% retracement at 154.19, even as a corrective move.

In the bigger picture, fall from 161.94 medium term is seen as correcting whole up trend from 102.58 (2021 low). Deeper decline could be seen to 38.2% retracement of 102.58 to 161.94 at 139.26, which is close to 140.25 support. In any case, risk will stay on the downside as long as 55 W EMA (now at 149.77) holds. Nevertheless, firm break of 55 W EMA will suggest that the range for medium term corrective pattern is already set.

Daily Pivots: (S1) 0.8630; (P) 0.8655; (R1) 0.8673; More….

Breach of 0.8631 minor support argues that USD/CHF's rebound from 0.8431 might have completed at 0.8701 already. Intraday bias is mildly on the downside for retesting 0.8431 low. On the upside, however, firm break of 38.2% retracement of 0.9223 to 0.8431 at 0.8734 will bring stronger rally to 61.8% retracement at 0.8920, even as a corrective move.

In the bigger picture, price actions from 0.8332 (2023 low) are currently seen as a medium term corrective pattern, with fall from 0.9223 as the second leg. Strong support could be seen from 0.8332 to bring rebound. Yet, overall outlook will continue to stay bearish as long as 0.9243 resistance holds. Firm break of 0.8332, however, will resume larger down trend from 1.0146 (2022 high).

Daily Pivots: (S1) 1.2792; (P) 1.2833; (R1) 1.2903; More...

Intraday bias in GBP/USD remains on the upside at this point. Pull back from 1.3043 could have completed at 1.2664 already. Further rise should be seen to retest 1.3043 resistance first. Firm break there will resume whole rally from 1.2998 to 61.8% projection of 1.2298 to 1.3043 from 1.2664 at 1.3124, which is close to 1.3141 high. On the downside, below 1.2754 minor support will turn intraday bias neutral first.

In the bigger picture, as long as 1.3141 resistance holds (2023 high), medium term corrective pattern from there could still extend with another falling leg. But even in that case, downside should be contained by 1.2036/2298 support zone. Meanwhile, decisive break of 1.3141 will confirm resumption of whole up trend from 1.0351 (2022 low).

Daily Pivots: (S1) 1.0938; (P) 1.0969; (R1) 1.1024; More.....

EUR/USD's break of 1.1007 confirms resumption of whole rally from 1.0665. Intraday bias is staying on the upside for 100% projection of 1.0665 to 1.0947 from 1.0776 at 1.1058. Decisive break there could prompt upside acceleration through 1.1138 resistance to 161.8% projection at 1.1232. On the downside, below 1.0985 minor support will turn intraday bias neutral first. But outlook will stay bullish as long as 1.0880 support holds.

In the bigger picture, price actions from 1.1274 are viewed as a corrective pattern that's could still extend. Break of 1.1138 resistance will be the first signal that rise from 0.9534 (2022 low) is ready to resume through 1.1274 (2023 high). However, break of 1.0776 support will extend the correction with another falling leg back towards 1.0447 support.