There has been much discussion in the media recently about how the Federal Reserve (the Fed) has successfully managed to direct the U.S. economy to a soft landing. But what does that actually mean and, ultimately, how does that impact investors? 

Here, we find out. 

What a soft landing looks like

In economic terms, a soft landing is when an economy slows down just enough to avoid a recession while maintaining positive growth and avoiding a sharp increase in unemployment. Inflation must also be kept in control, and a central bank will intervene to stop it soaring. A soft landing can be achieved through monetary policy adjustments, such as raising interest rates or lowering them when needed. However, central banks must do so in a way that does not cause an economic contraction. 

Since the pandemic, the Fed has been trying to orchestrate a soft landing for the U.S. economy through tighter monetary policy. They raised interest rates and kept them far higher than they have been for decades. They did so in an effort to moderate inflation, whilst ensuring the labor market stayed robust and economic growth was steady. 

Current financial data would suggest they are on course for achieving a soft landing. For instance, the latest U.S. unemployment rate dropped from 4.2% to 4.1%, while inflation has fallen from its 2022 peak of 9.1% to 2.5% in August 2024. 

In fact, in September, the Fed made its first interest rate cut in four years because of the latest economic data. Despite unemployment rates still being low, the labor market was seen to be cooling while growth was slowing. The Fed, therefore, made a cut to stimulate the economy – fearing that if they kept rates high for much longer, the economy would miss its soft landing and go into a recession.

The impact of a soft landing

But, assuming that the Fed has managed to pull off a soft landing, there is reason for optimism for investors – especially with the increased likelihood of more interest rate cuts in the near future. 

Lower interest rates are supportive of growth as they make borrowing cheaper. For consumers, that means mortgages and other household loans are less expensive. For companies, it means they can take out debt at a lower price so they can expand more easily. In short, lower interest rates encourage spending which is how an economy grows. 

While that all sounds very positive, though, it is important to remember why the Fed cut rates in the first place: they were worried about the prospect of an economic contraction. While the drop in the latest unemployment figures would undoubtedly have been a good thing, the Fed was obviously concerned enough about the overall health of the economy in September to take action—and comparatively drastic action, too. The rate cut was 50bps, when cuts are typically only 25bps. 

Investors may be better placed, then, to remember that just because the Fed has initiated a rate-cutting cycle, not all risk has evaporated—far from it. The market is still extremely volatile. For instance, geopolitical risks are rife, which could easily cause problems for supply chains, among other issues. 

Potential shocks have the power to cause dramatic drops in asset prices, particularly if those prices have risen simply because the wider economic environment was perceived to be better. Remember, just because interest rates are lower, it doesn’t automatically mean that all businesses will succeed or thrive. 

As a result, maintaining a cautious, fully informed approach remains one of the best ways to mitigate risks. Lower rates do offer the opportunity for growth, but investors need to frame that with the Fed’s underlying economic concerns. For, while the Fed may well have managed to pull off a soft landing, which is a better outcome than an all-out recession, risks still loom large. 

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