Soft landing: what do economists mean when they talk about hard and soft landings? Photo / 123rf
OPINION
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Q: I keep reading about the prospects of the US achieving a soft landing for the economy.
What do the terms soft and hard landing actually mean?
(T. Wood)
A: I’m glad you mentioned the US because it is still a live debate there. New Zealand has had a hard landing because, in simple terms, when economists talk about hard and soft landings they are referring to recession.
Specifically, it refers to whether policymakers can bring down inflation by lifting interest rates without putting the economy into recession.
No recession = soft landing. Recession = hard landing.
In his much-anticipated speech to last weekend’s gathering of central bankers at Jackson Hole, US Federal Reserve chairman Jerome Powell almost declared victory in the war on inflation.
“The time has come for policy to adjust,” Powell said during the Kansas City Fed’s annual conference in Wyoming. “The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook and the balance of risks.”
It doesn’t get any clearer than that from a central banker outside a rate decision. The US is set to start cutting rates and the first will come at the next Fed meeting on September 18.
Markets were happy and immediately rallied. But news that the inflation fight is won (for this cycle at least) saw the focus at Jackson Hole shift immediately to whether or not the US can pull off a soft landing.
To date, the US economy has proved highly resilient to rising rates and a soft landing is on the cards.
It would be a very rare victory if recession is avoided at this point in the cycle. It has only been achieved once, twice or possibly three times in the US.
This should tell you how widely debated everything about this concept always is. For the record, the candidates for soft landing are the cycles of 1965-67, 1984-87 and 1994.
Reporting from Jackson Hole, the Financial Times notes a good deal of optimism about the prospects this time.
“Andrew Bailey, governor of the Bank of England, and his counterpart at the Fed, Jay Powell, hit back at fears that growth would need to be sacrificed to reach their inflation goals. As they began to cut borrowing costs, both men signalled they were still on course to avoid a recession. Economists in the audience echoed their optimism.”
Here’s hoping. When it comes to US cycles, Wall Street has a lot of power. It is typically big market crashes that undo efforts for soft landings. That looked like it was happening a few weeks ago when the Fed failed to deliver an August rate cut and Wall Street threw a temper tantrum.
But investors seem to have been calmed for now. Call me superstitious but I’m always a little nervous as we head into the US autumn (or fall, as they call it).
The Wall Street Crash of 1929 and Black Monday in 1987 were both in October. The 2008 Global Financial Crisis (GFC) peaked in September and through October.
It would be a stretch by almost any measure to say New Zealand has managed a soft landing. The economy has dipped into recession twice since the Reserve Bank started lifting rates and (based on the bank’s own forecasts) is probably in a third recession right now.
Then there’s per-capita GDP, which has been going backwards for two years.
But relative to the economic cycles of the past few decades, it hasn’t been an especially hard landing (yet).
The recessions so far have been shallow (albeit propped up by high net migration). Unemployment is still below 5%, historically very low. And despite some grim headlines and high-profile business failures, credit arrears, mortgagee sales and business liquidation remain much lower than they were during the GFC and years after.
The question now is how bad will it get before the fair winds of lower rates take hold.
A lot will depend on sentiment and how much optimism lower rates instil in consumers and businesses.
We get ANZ Business Outlook and Consumer Confidence figures on Thursday and Friday this week.
ASB chief economist Nick Tuffley reckons the primary reaction has been relief.
“Informal sentiment surveying (i.e. having conversations with people) suggests there is a mood of relief for the main, though understandably less joy amongst depositors,” he wrote on Monday.
“Households bearing the brunt of higher debt servicing costs on $360b of debt, which is 65% of all private sector debt, will be feeling some weight coming off their shoulders. The good news is we think the effective mortgage rate is around its peak now.”
Tuffley notes that there will still be some homeowners rolling off low fixed rates and getting hit in the pocket. But that should start giving way to those rolling off shorter terms who will gain from new lower rates.
“The more popular fixed terms, out to the two-year tenor, are now the lowest they have been since around October-November 2022,” he says.
The gloomiest analysis I’ve seen to date comes from UBS economists, who warn that the Reserve Bank (RBNZ) is already at risk of overshooting and will have to start worrying about deflation if it doesn’t cut rates quickly from here.
That take, from the Sydney-based economists, was based on retail trade data released on Friday. It was pretty grim stuff.
Seasonally adjusted retail sales dropped 1.2% in the June quarter compared with the March quarter. That was the eighth consecutive quarter to see a drop, reflecting the still-present cost-of-living pressures on customers, Stats NZ said.
“The last time we saw several quarters of consistent falls was between 2007 and 2009, which coincided with the Global Financial Crisis,” Stats NZ business financial statistics manager Ricky Ho said.
Eleven of the 15 industries had lower sales in June compared with March in the quarter.
This highlighted “a material further deterioration in pricing power for New Zealand retailers in [the second quarter],” UBS wrote in its commentary.
“The change in the retail trade price deflator turned negative to -0.1% [in the second quarter], slowing further from +0.1% [in the first quarter] and +0.4% [in the last quarter of 2023].”
In other words, it wasn’t just disinflationary, it was deflationary!
“Unlike CPI, this data set is seasonally adjusted. Hence, it implies retail prices were deflating at an annualised pace of [approx] -0.3%,” UBS said.
Remember deflation? It’s what we used to worry about pre-pandemic when inflation was so low that the economy was at constant risk of stalling. Back then, the Reserve Bank was contemplating whether it could take interest rates below 0% if needed.
If the retail deflator continues trending flat to negative then New Zealand’s headline Consumer Price Index (CPI) is likely to drop below 2% by the final quarter of this year, UBS said.
Its current forecast for the fourth quarter is 2.1%, compared to the RBNZ’s pick of 2.3%.
“If CPI were to fall below the RBNZ’s target midpoint of 2%, it would make New Zealand a global outlier,” UBS said.
And if that were to happen, the RBNZ would have to start cutting in 50-basis-point increments.
For the record, UBS’s base case assumes the RBNZ lowers the OCR from 5.25% with a “relatively rapid” series of back-to-back 25 basis point cuts down to 3%, by the end of 2025.
Q: One thing I still don’t get is Government Bonds. Who buys them? Is it international banks? How are they paid back? Does the Government go out and sell them? What if no one wants them? Are they basically a contract that says “you give us money and we promise to pay it back at this interest rate”? Are they actually bits of paper?
M. Heath
A: All great questions. Broadly yes, buyers are international banks and big pension funds. Most people’s KiwiSaver account probably has some bonds in it, depending on how aggressive their settings are.
The idea is that sovereign governments offer a very stable economic platform from which to offer investment returns and they can use that to borrow relatively cheaply.
That’s not always true of course. Countries with unstable political environments are much riskier bets for investors.
But broadly, countries like New Zealand can sell bonds to raise funds. For investors, the payoff is a guaranteed rate of return, buffered from the ups and downs of the sharemarket. The trade-off is that the rates of return are generally lower than sharemarket investments.
Treasury has a Debt Management Agency that issues the bonds into the market. They are purchased by registered “primary dealers”, who then sell them on secondary bond markets.
The primary dealers are the institutional arms of all the big banks operating in New Zealand. According to the Treasury website, the primary dealers currently registered are ANZ, BNZ, Westpac, CBA (ASB’s parent), JP Morgan Australia, UBS Australia and Citigroup global markets.
They bid for bonds on issue and that sets a price for them. If no one wants them, then the price falls. But if the Government really can’t find buyers for all its bonds, then it generally means the economy is in trouble and probably needs to offer higher interest rates.
That’s one of the reasons we worry so much about our international credit rating.
Occasionally, Treasury fails to shift all the bonds it has issued. That’s happened more in the past couple of years as the Government has issued more to cover Covid-era spending.
Finally, these days bonds are electronic but they used to be paper certificates. In fact, British bonds used to have fancy gilded gold leaf borders, which is why you’ll sometimes hear bonds described as gilts.
Liam Dann is business editor-at-large for the New Zealand Herald. He is a senior writer and columnist, and also presents and produces videos and podcasts. He joined the Herald in 2003. To sign up to his weekly newsletter, click on your user profile at nzherald.co.nz and select “My newsletters”. For a step-by-step guide, click here. If you have a burning question about the quirks or intricacies of economics send it to liam.dann@nzherald.co.nz or leave a message in the comments section.
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