Ellen Zentner: Is a Soft Landing for the U.S. Still Possible?

While the U.S. economy looks to be on track for a soft landing in 2023, even the smallest of setbacks could spell trouble for the end of the year.

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Welcome to Thoughts on the Market. I'm Ellen Zentner, Morgan Stanley's Chief U.S. Economist. Along with my colleagues bringing you a variety of perspectives, today I'll discuss our view around the soft landing for the U.S. economy. It's Friday, May 19th, at 10 a.m. in New York. 

Last year, we presented our outlook that 2023 would see a soft landing for the U.S. economy. This out of consensus view continues to be our base case expectation. And we looked at several key data points as evidence to support it, including the U.S. housing cycle, income and spending dynamics, the labor market and inflation. 

To start, economists have long said, "As goes housing, so goes the business cycle." And housing is a very important factor in our outlook for a soft landing. While the decline in housing activity has been record breaking from a national perspective, Morgan Stanley's housing strategists believe the cycle is bottoming. In our forecast, the big drag on economic growth from the housing correction should turn neutral by the third quarter of 2023, providing some cushion against the growth slowdown elsewhere. 

Second, the incoming data on U.S. income and consumer spending also support our expectation that the economy is slowing but not falling off a cliff. On the one hand, discretionary consumer spending is softening. On the other hand, income is the predominant driver of consumer spending, and even as wage growth continues to slow, our forecasted path for inflation suggests that real wages will finally turn positive in the middle of this year. 

Third, we look to labor market dynamics, and the April U.S. employment report provides ample evidence that the labor market is slowing but is also not headed for a cliff. The steady decline in job postings with still low unemployment rates since the middle of last year supports our soft landing view. 

And finally, we closely monitor inflation. The most recent April data suggests that core inflation continues to slowly recede, tracking in line with our forecasts, as well as the Fed's March projections. We think the incoming data continue to support a Fed pause at the June meeting, and after June we can see a wide range of potential outcomes for the policy rate. We expect a gradual slowing in core inflation that keeps the Fed on hold until March 2024, when it begins to normalize policy with quarter percent rate cuts every three months.   

To be sure, the possibility of a recession remains a concern this year amid banking pressures with unknown spillovers to the economy from tighter credit. Should credit growth slow more than expected, it would bring larger spillovers to investment, consumption and labor. Against this backdrop, we expect the U.S. economy to experience a sharp slowdown in the middle two quarters of the year, so even small hiccups could push us into a recession. We'll continue to keep you abreast of any new developments. 

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