Forget a soft landing. The market’s best hope is a ‘growth’ recession

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New York CNN Business —

Investors are becoming aware of the harsh reality of how much pain the economy may endure as the Federal Reserve continues its battle against stubbornly high inflation.

The Fed softened its tone at last week’s policy meeting warning of serious economic hardship, and markets finally took the central bank’s word for it.

Already in a bear market, the S&P 500 saw another major decline on Friday. The Dow fell short in bear territory, closing at its lowest level since 2020.

But while investors have balked at whether the Fed will hit a “hard” or “soft” landing, there is a third, intermediate possibility where everything feels a little bad for an extended period of time. Right now, that economic purgatory may be investors’ best hopes.

What’s happening: The Fed has pursued the same goal since it started raising interest rates in March to fight inflation. It wants to achieve a soft landing — that Goldilocks ideal of cooling the economy enough to drive prices down, but not enough to trigger a recession. But the idea has become increasingly untenable as inflation rates remain stubbornly high as economic data weakens.

The new target appears to be a so-called growth recession: a prolonged period of meager growth and rising unemployment. The pain is more intense and lasts longer than a soft landing, but a ‘growth’ recession won’t contract the entire economy as a real recession would. It looks like a recession and feels like a recession, but it’s not a recession – at least not officially.

Last week’s updated economic projections from the central bank showed that it expects to end up in this scenario. Policymakers have revised their forecasts for economic output down to the end of 2024 and raised forecasts for the unemployment rate from their latest projections published in June.

Last week, Fed Chair Jerome Powell acknowledged that the dream of a soft landing is over. “Reducing inflation will probably require a sustained period of below-trend growth,” the chairman said after announcing another three-quarters percentage point rate hike. There will most likely be some easing in labor market conditions, he added.

A growth recession is still painful. At best, said Joe Brusuelas, chief economist at RSM US, between five and six million US jobs would need to be lost to bring inflation back to the Fed’s target of 2%.

Declaring the recession could be an academic exercise anyway, said Kevin Gordon, senior investment research manager at Charles Schwab, as people are already suffering economically.

Low-income Americans are experiencing negative real wage growth, investors are losing serious money across multiple asset classes, homebuyers are locked out of an overpriced housing market, and renters are struggling to pay their rents.

The bottom line: Raised house prices, painful technology stocks, hot inflation and war in Europe are weighing on investors. The Federal Reserve’s new warning that it is not afraid of causing economic pain is adding to the noise. Goldman Sachs and Bank of America both lowered their annual S&P 500 targets last week.

“We can expect continued market turbulence for some time,” said Brad McMillan, Chief Investment Officer for Commonwealth Financial Network.

But there is a silver lining. “The Fed is currently operating on the economy,” McMillan said. “In the short term, it’s painful. But in the long run? It is a healing process and one that is paving the way for a healthier economy and markets.”

The new British government on Friday announced a sweeping plan to save the UK economy from recession.

By announcing the biggest tax cuts in 50 years while boosting spending, Finance Minister Kwasi Kwarteng defended the government’s focus on growth despite lingering inflation problems as a “new approach for a new era”.

Markets immediately made it clear that they weren’t big fans of the approach, reports my colleague Julia Horowitz.

The British pound plunged below $1.10 in mid-afternoon, hitting a new 37-year low against the greenback before plunging to its all-time low against the US dollar early Monday. UK government bonds have also sold out strongly, pushing yields soaring.

Investors expressed confusion over the unconventional approach where the government would borrow tens of billions more to boost spending, just as the Bank of England is trying to cool the economy to curb inflation. On Thursday, the central bank pushed its key rate to its highest level since 2008, the seventh rate hike since December.

New Prime Minister Liz Truss defended her administration’s controversial announcement Friday in an exclusive interview with CNN’s Jake Tapper. Truss told Tapper that by cutting taxes, her administration “encouraged businesses to invest and we also help ordinary people with their taxes.”

Marc Benioff and Elon Musk have something in common.

The Salesforce chairman and co-CEO loves Twitter. If it were up to him, he told CNN’s Poppy Harlow in an interview, he would “definitely” buy the social media platform.

But unlike Musk, he’s not really going to make an offer.

“I will never buy Twitter,” Benioff clarified to Harlow. “Just because I want something doesn’t mean I’m going to have it… I’d like to have a sundae right now with three scoops of ice cream, chocolate sauce and whipped cream and a cherry. But I’m not going to have it.”

His comments come amid Twitter’s legal battle with Elon Musk, who offered to buy the company but then canceled the deal, reports my colleague Paul R. La Monica.

Still, he thinks there could be a huge, unrealized benefit to the company. Twitter, he said, “is the biggest, most unrealized, most unmonetized brand” in technology, adding that “it’s a great company, a great brand, a great platform and can do incredible things going forward. ”

Salesforce was considering a Twitter deal in 2016. But it wasn’t to be, as Salesforce investors are resisting the idea of ​​a Twitter takeover.

Salesforce eventually struck another big deal, buying the Slack employee collaboration app for $27.7 billion in late 2020.

Boston Fed President Susan Collins, Atlanta Fed President Raphael Bostic, Dallas Fed President Lorie Logan and Cleveland Fed President Loretta Mester are all speaking.

Later this week: US consumer confidence, US new home sales and the end of the third quarter.

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