HAMISH MCRAE: A soft landing is in sight for economy

A ‘soft landing’ – that’s what the financial markets expect the global economy to achieve this year, and I think they may be right.

The idea is this. The world’s central banks must walk a narrow line. On the one hand, they run the risk of pushing inflation too hard by driving up interest rates, leading to a housing collapse, corporate failures, a surge in unemployment and, the dreaded R-word, recession. That would be the hard landing this summer.

On the other hand, they may be lulled into complacency by falling headline inflation, relax too quickly, only to have to raise interest rates again at the end of the year. That, in turn, could lead to a hard landing next year.

Between the two lies the hope that they will do enough to contain inflation, aided by falling energy and commodity prices, so that the slowdown this summer will be just that: a slowdown, not a recession. That’s the soft landing.

There have been encouraging signs in recent days. Here in the UK, the economy continued to grow in November, suggesting there may not have been a recession in the second half of last year.

I’ve long felt that we could squeak without one last year, and it would be nice if that image worked out.

In Germany, much the same seems to be happening: it seems that there was no recession in 2022. In the US, inflation is falling sharply and is now at 6.5 percent.

That will put some pressure on the Federal Reserve to be overly aggressive in raising rates. We get the UK numbers this week, and the question here is really how fast they come down – see our story on that below.

If you want to take one indicator of how markets are reacting to this stream of encouraging news, it’s the FTSE100 index. The Footsie closed at 7,844 on Friday – within a whisker of its all-time high of 7,877 on May 22, 2018. About time, I say, as UK assets are still substantially undervalued by world standards.

Clearly, the 8,000 level is in sight, and assuming there won’t be a severe global recession this year, the market could go much further. Remember that most of the revenue for the Footsie businesses comes from outside the UK, so this is also a reflection of demand in the global economy.

The big message is that even if a recession does come, it won’t be a bad one and the UK will do better in the coming months.

Dean Turner, chief economist for the UK and the eurozone at UBS Wealth Management, put the point well in a note Friday. He wrote, “The economic reality is likely to be less dire than the headlines suggest. In addition, we think UK equities can continue to perform well in the coming months. We also see better times ahead for the pound.’

I think that’s right, and it’s a welcome relief from the relentless gloom of too many commentators. But I recognize that there are genuine concerns, not so much about this year, but about the next three to five years. There is an economic cycle. There will be a kind of dip and then there will be growth again. But the uptick in this coming cycle will run into two serious headwinds.

First, the world carries a huge load of debt: households, companies, governments and so on. If, as I expect, the world returns to positive real interest rates—interest rates above inflation—it will pose serious problems for those who have borrowed too much.

Second, while the counter-movement to globalization makes sense – why make something on the other side of the world when you can have it made just around the corner? – it will increase costs.

The idea of ​​near-shoring and friend-shoring rather than offshoring is tempting, but globalization has been one of the drivers for higher living standards. It will be difficult to maintain the best aspects of a freely tradable global economy against what appears to be an increasingly difficult political environment.

So let’s raise a glass when the Footsie hits a new high, and another when it goes through 8,000. There is a slog ahead. But a soft landing is much better than a hard one.