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At July's Federal Open Market Committee (FOMC) meeting, the Fed decided to raise interest rates by 25 basis points, marking the 11th rate hike since March of last year. This round of rate hikes is unprecedented, and the current rate hike path is steeper than any previous hikes, as shown in the figure below, raising concerns about whether the US economy will experience a hard or soft landing.

Some investors are pessimistic and doubt that a soft landing is possible with such a sharp rise in interest rates. This has been a common criticism of the Fed's aggressive monetary policy since last year. However, recent drops in inflation seem to suggest that the balance between inflation and employment has not seriously tilted towards either side of the scale, indicating that the US labor market remains relatively strong despite the increase in interest rates.

But can the US achieve a soft landing as suggested by economic data? Let's break it down.

• What is a soft landing?

It generally refers to when inflation approaches its 2% target, and the economy and employment do not experience significant decline. Achieving this in practice is challenging and requires authorities accurately judge and effectively implement policies.

• Has the US achieved a soft landing before?

Yes, during 1994-1995 under former Fed Chairman Alan Greenspan's leadership, when interest rates were raised to 6%, and the economy did not experience severe recession, as shown by the graphs below.

• How was this achieved?

According to Bloomberg analysts, the US achieved a soft landing during 1994-1995 when inflation declined, unemployment stabilized, and Gross Domestic Product (GDP) growth slowed, but still remained above 2% in 1995.

Historically, the US has achieved several "fairly soft landings", according to Fed's Vice Chairman Alan Blinder.

For example, the Fed began raising interest rates two years prior 2001, resulting in a mild eight-month economic recession, with real GDP down by only around 0.1%.

Some may wonder why a soft landing isn't guaranteed this time since it happened before.

It's important to note that this round of inflation has hit a 40-year high, and the speed and strength of this rate hike are unprecedented. We're currently at a critical juncture in this rate hike cycle, and the success or failure of achieving a soft landing will likely depend on the monetary policies of the Fed.

According to Bloomberg, there has been a significant decline in inflation as measured by Consumer Price Index (CPI). From a structural perspective, the prices of energy and commodities, major components in CPI, have fallen back from their peak levels, pushing the CPI value down. Another key factor behind the declining CPI is known as the base effect. When analyzing the CPI, we primarily use year-on-year data. In the first half of 2022, the CPI increased on a monthly basis and reached a historical peak in June, which led to a comparatively lower year-on-year CPI figure for that month this year.

While inflation shows signs of cooling down, it remains difficult to predict whether this trend will continue.

It could be due to the following two factors: As the CPI has gradually declined month by month in the second half of 2022, the high base effect has also been gradually weakening. Additionally, we can observe that the service sector still represents a relatively large share of the CPI in June, and it may prove challenging to achieve significant short-term decreases. This is further supported by the strong service Purchasing Managers' Index (PMI) as well as job growth in the industry, which suggests that any sharp declines are less likely to occur in the near future.

Let's take a closer look at another key indicator that shows how the service sector is performing in comparison to other industries. In August, the PMI indicator for the manufacturing industry published by Institute for Supply Management (ISM) showed a small improvement from June's figure but still remained below the 50% threshold. In contrast, the service industry PMI has shown strong performance throughout this year. The latest reading was 54.5%, which is above the 50% break-even point, indicating that the service industry is relatively prosperous.

In terms of employment situations, the Labor Department reported that non-farm payroll job additions in August were higher than market expectations. The Unemployment Rate climbed to 3.8% in August from 3.5% in July, reaching the highest level since February 2022, while the Labor Force Participation Rate improved from 62.6% to 62.8%. While the nonfarm payrolls growth continued to defy expectations, previous months’ counts were revised considerably lower.

Markets widely expect the Fed to skip a rate increase at its Sept. 19-20 meeting. However, market pricing still points to about a 38% probability of a final hike at the Oct. 31-Nov. 1 meeting, according to CME Group data.

In conclusion, it is still uncertain whether a soft landing will occur and what the future holds in this regard.

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