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The asset allocation implications of no landing, soft landing, and hard landing are very different, see chart below.
Under the no landing scenario, the economy will remain strong and the Fed will hike rates faster. A higher discount rate and the Fed stepping harder on the brakes to tighten financial conditions will be negative for equities.
Under the soft landing scenario, inflation comes down to 2% by the end of 2023, rates move sideways because there is no need for the Fed to raise rates when inflation is coming back to 2%, and equities will move higher.
Under the hard landing scenario, the economy enters a recession, which means a significant decline in earnings and growth, which pushes rates lower and equities lower.
The bottom line is that the investment implications for equity and bond markets are very different depending on which scenario we are in, and at the moment, it is clear that we are firmly in the no landing scenario.
Once the Fed has raised interest rates enough to get inflation under control we will find out if we are transitioning to a soft or hard landing. It could be that we have to wait until 2024 before we find out what comes after no landing.
Investors today can decide to say: “But we will get a hard landing,” or “We will get a soft landing”. But if that view turns out to be wrong, it will be costly for performance.
In short, with the economy still strong and inflation still high, it is too early for asset allocation to be positioned for a soft landing or a hard landing. For now, investors should be positioned for no landing.
Source: Apollo Chief Economist See important disclaimers at the bottom of the page.
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Loan loss provisioning is rising from a very low level in the banking sector, but we are still not close to the levels seen in 2008 and during the pandemic, see chart below. For more discussion, see also this BIS paper.
Source: Bloomberg, Apollo Chief Economist (Note: KBW Bank Index includes 24 banks and regional institutions: JPM, PNC, WAL, BAC, C, TFC, BK, SBNY, CMA, CFG, RF, MTB, SIVB, FITB, HBAN, NTRS, KEY, STT, USB, FRC, ZION, EWBC, COF, WFC) See important disclaimers at the bottom of the page.
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Bankruptcies are rising in Europe across all sectors in the economy, see chart below.
Source: Eurostat, Apollo Chief Economist See important disclaimers at the bottom of the page.
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With hedging costs rising, Japanese investors have been selling foreign bonds, see chart below. With US rates staying higher for longer, this is likely to continue.
Source: Bloomberg, Apollo Chief Economist See important disclaimers at the bottom of the page.
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The price of transporting a container from China to the US is basically back at pre-pandemic levels, and this is boosting manufacturing production and putting downward pressure on goods inflation, see chart below.
Source: WCI, Bloomberg, Apollo Chief Economist See important disclaimers at the bottom of the page.
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Weekly data shows that hotel occupancy rates are rising, daily rates are increasing, and RevPar is moving higher, see chart below. No signs of a consumer slowdown here.
Source: STR, Haver Analytics, Apollo Chief Economist See important disclaimers at the bottom of the page.
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Our latest US housing outlook is available here.
Source: Census, Haver Analytics, Apollo Chief Economist. Note: Single family homes are 1 unit buildings. See important disclaimers at the bottom of the page.
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The ongoing no landing is not just about waiting for the lagged effects of Fed hikes, it is also about the level of the Fed funds rate not being high enough to cool the economy down.
The no landing scenario is playing out because the Fed has not raised interest rates enough, and as a result, even the interest rate-sensitive components of GDP are now starting to recover because of continued strong job growth, high wage growth, and high excess savings across the income distribution. As time goes by, the economy begins to adjust to a new higher level of inflation and a new higher level of interest rates.
Most notably, the housing market is starting to rebound, see charts below. Traffic of prospective buyers of new homes is rebounding, homebuilder sentiment and homebuyer sentiment are rebounding, new home sales are beginning to recover, the average number of offers received per sold property is starting to recover, active listings are still very low, and indicators suggest that homesellers are simply not selling their home if they don’t like the price they are being offered. This makes sense with continued strong job growth, strong wage growth, and high household savings.
With the housing market recovering, the risks are rising that the expected strong rollover in the shelter component of the CPI index may never happen, see the last chart.
Source: National Association of Homebuilders, Bloomberg, Apollo Chief Economist 
Source: University of Michigan, NAHB, Haver Analytics, Apollo Chief Economist 
Source: Census Bureau, NAR, Haver, Apollo Chief Economist; Forecast is Bloomberg consensus 
Source: NAR, Apollo Chief Economist 
Source: Bloomberg, Apollo Chief Economist 
Source: Mortgage Bankers Association, Bloomberg, Apollo Chief Economist 
Source: University of Michigan, Apollo Chief Economist 
Source: University of Michigan, Apollo Chief Economist 
Source: Realtor.com, Apollo Chief Economist 
Source: NAR, Apollo Chief Economist 
Source: Zillow, BLS, Haver Analytics, Apollo Chief Economist See important disclaimers at the bottom of the page.
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With core PCE inflation in January rising to 4.7%, the unemployment rate at the lowest level since the 1960s, and 2-year breakeven inflation expectations becoming unanchored, the Fed is about to turn significantly more hawkish.
Based on the latest data for inflation and unemployment, the Taylor Rule is now suggesting that the Fed funds rate today should be almost 10%, and it is becoming clear for the Fed that a sharper slowdown in the economy is needed to get inflation under control, in particular with the housing market showing signs of rebounding.
A generation of investors has since 2008 been taught that they should buy on dips, but today is different because of high inflation, and credit markets and equity markets are underestimating the Fed’s commitment to getting inflation down to 2%.
The Fed is now so far away from its dual mandate that the FOMC may not only consider using more hawkish forward guidance and raising the Fed funds rate but they could also accelerate the rundown of their balance sheet. The no landing scenario continues and the consequence is that we will continue to have high volatility in markets.
Source: Bloomberg, Apollo Chief Economist See important disclaimers at the bottom of the page.
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The PCE inflation data that came out on Friday shows that the Fed’s preferred measure of inflation, namely core inflation excluding housing, also known as supercore inflation, increased in January to 4.6%, dramatically above the Fed’s 2% inflation target. The economy outside the interest rate-sensitive components – which only make up 20% of GDP – is simply not slowing down.
Even the housing market is starting to show signs of a rebound, driven by strong job growth, high wage growth, and high levels of savings across the income distribution, which is particularly problematic given the consensus expectation that OER should be declining over the coming quarters. As a result, the Fed has to raise interest rates more, and this continues to be a downside risk to equity and credit markets.
A Fed-driven tightening in financial conditions with higher rates, lower equities, and wider credit spreads increases the probability that no landing will be followed by a hard landing.
Source: BEA, Haver Analytics, Apollo Chief Economist See important disclaimers at the bottom of the page.
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