Is an economic soft landing still possible?

Morgan Stanley Wealth Management


Summary: With the Federal Reserve’s recent 75-basis-point rate hike, the probability of recession has risen. How should investors prepare for what may come next?

On June 15, the Federal Reserve raised interest rates by 75 basis points, the biggest single increase since 1994—and signaled more big hikes to come—in its continued effort to tame the highest inflation the US has seen in 42 years.

Morgan Stanley’s Global Investment Committee (GIC) believes the Fed may have created more questions than answers, especially since it said previously that a rate hike of that size was “off the table.” While markets initially cheered the Fed’s announcement, recession risk is actually rising. Here’s what investors should know.

The Fed is dialing it up…

The Fed suggested there could be continued acceleration in policy-tightening, raising forecasts that the fed funds rate could rise to over 3% by year’s end and top out at 3.8%, well ahead of most economists’—and the Fed’s own—previous forecasts. Such aggressive positioning to slow the economy means greater risk of actually tipping it into a recession.

…just as inflation may be peaking

Further complicating the Fed’s efforts is emerging evidence that inflation may be peaking and the economy cooling on its own. While May’s consumer price index (CPI) showed the largest year-over-year increase since 1981 at 8.6%, recent producer price index (PPI) data, which measures wholesale prices of goods and services before they reach consumers, was better than expected on almost every score.1

In addition, price gains for goods are starting to decelerate as supply chains clear, inventories rebuild, and demand cools, as evidenced by weaker retail sales. Housing-related demand is also slowing. And, perhaps most compellingly, the Atlanta Fed is currently forecasting 0% quarter-over-quarter GDP growth for the second quarter, following negative growth in the first quarter.1

Looking ahead

This all raises the question: Is a true economic “soft landing” still possible? According to the GIC, it is—but the possibility may now be slim. Still, it’s important to maintain perspective. Both the economy and markets have weathered this kind of turbulence before.

The takeaway for investors: Focus on diversification. Investment grade bonds, international stock funds, and small- and mid-cap stocks—especially in biotech, financials, energy, and industrials—may help round out portfolios.

The source of this Morgan Stanley article, Is an Economic Soft Landing Still Possible?, was originally published on June 22, 2022.

  1. Morgan Stanley Wealth Management Global Investment Committee, “Fed Up,” June 21, 2022

Risk Considerations

Yields are subject to change with economic conditions. Yield is only one factor that should be considered when making an investment decision.

Equity securities may fluctuate in response to news on companies, industries, market conditions and general economic environment.

Bonds are subject to interest rate risk. When interest rates rise, bond prices fall; generally the longer a bond's maturity, the more sensitive it is to this risk. Bonds may also be subject to call risk, which is the risk that the issuer will redeem the debt at its option, fully or partially, before the scheduled maturity date. The market value of debt instruments may fluctuate, and proceeds from sales prior to maturity may be more or less than the amount originally invested or the maturity value due to changes in market conditions or changes in the credit quality of the issuer. Bonds are subject to the credit risk of the issuer. This is the risk that the issuer might be unable to make interest and/or principal payments on a timely basis. Bonds are also subject to reinvestment risk, which is the risk that principal and/or interest payments from a given investment may be reinvested at a lower interest rate.

Asset allocation and diversification do not assure a profit or protect against loss in declining financial markets.

Rebalancing does not protect against a loss in declining financial markets.  There may be a potential tax implication with a rebalancing strategy.  Investors should consult with their tax advisor before implementing such a strategy.

Because of their narrow focus, sector investments tend to be more volatile than investments that diversify across many sectors and companies. Technology stocks may be especially volatile.

International investing entails greater risk, as well as greater potential rewards compared to U.S. investing. These risks include political and economic uncertainties of foreign countries as well as the risk of currency fluctuations. These risks are magnified in countries with emerging markets, since these countries may have relatively unstable governments and less established markets and economies.

Investing in foreign emerging markets entails greater risks than those normally associated with domestic markets, such as political, currency, economic and market risks.

Investing in commodities entails significant risks. Commodity prices may be affected by a variety of factors at any time, including but not limited to, (i) changes in supply and demand relationships, (ii) governmental programs and policies, (iii) national and international political and economic events, war and terrorist events, (iv) changes in interest and exchange rates, (v) trading activities in commodities and related contracts, (vi) pestilence, technological change and weather, and (vii) the price volatility of a commodity. In addition, the commodities markets are subject to temporary distortions or other disruptions due to various factors, including lack of liquidity, participation of speculators and government intervention.

Certain securities referred to in this material may not have been registered under the U.S. Securities Act of 1933, as amended, and, if not, may not be offered or sold absent an exemption therefrom.  Recipients are required to comply with any legal or contractual restrictions on their purchase, holding, and sale, exercise of rights or performance of obligations under any securities/instruments transaction.

The returns on a portfolio consisting primarily of environmental, social, and governance-aware investments (ESG) may be lower or higher than a portfolio that is more diversified or where decisions are based solely on investment considerations. Because ESG criteria exclude some investments, investors may not be able to take advantage of the same opportunities or market trends as investors that do not use such criteria. The companies identified and investment examples are for illustrative purposes only and should not be deemed a recommendation to purchase, hold or sell any securities or investment products. They are intended to demonstrate the approaches taken by managers who focus on ESG criteria in their investment strategy. There can be no guarantee that a client's account will be managed as described herein.

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