Opinion: Did we achieve a soft landing?

David Richards

The Federal Reserve has several responsibilities but one we are most familiar with is its dual mandate: price stability and full employment. Managing these two major economic variables under the best of circumstances is challenging – and over the last five years it has been downright daunting.

During COVID, the U.S. intentionally shut down the economy and asked individuals to stay home. In an effort to avert an economic crisis, the federal government engaged in unprecedented fiscal policy and the Federal Reserve aggressively adjusted monetary policy. These aggressive measures worked. The U.S. economy experienced a brief recession but staved off a more severe economic depression. In fact, these drastic measures may have worked too well. According to the Bureau of Labor Statistics, in April 2022 the unemployment rate was alarmingly low at 3.1%. There were 12.1 million job openings and only 5.7 million unemployed individuals. In June 2022 inflation (consumer price index) came in at 9.1% – the highest inflation rate seen in nearly 40 years.

The Fed has quantified the ideal target inflation rate at 2% core personal consumption expenditures, or PCE. Regarding unemployment, most economists agree a healthy unemployment rate ranges somewhere between 4%-5%. The Federal Reserve Bank of St. Louis just published a paper in June and declared the natural rate of unemployment at 4.1%. They defined the natural rate of unemployment as the “minimum unemployment rate in a healthy economy.” The challenge for the Fed was to move from this overheated economy closer to the established targets without creating a recession – the proverbial soft landing.

In March 2022, the Fed began to raise rates from essentially zero to 5.25%-5.5% by the end of 2023. The U.S. had not seen a Fed funds rate above 2.5% since before the financial crisis in 2008. In 2024, the Fed reduced interest rates by 100 basis points as both inflation and employment began moving toward their targets but have since paused, leaving the Fed funds rate currently at 4.25%-4.5%.

The Fed’s preferred inflation measure, core PCE, peaked in March 2022 at 5.3%. It slowly declined through June 2024 to 2.6% but has oscillated between 2.6%-3% since and was most recently reported at 2.8% in July, moving away from the Fed’s target of 2%.

The labor market is weakening but remains relatively strong, moving back into a healthy equilibrium. Even after substantial downward revisions, the BLS reported a July unemployment rate of 4.2%, 7.4 million job openings and 7.2 million unemployed. Hourly earnings remained strong at 3.9%, surpassing the rate of inflation. All these are indicative of a relatively strong labor market.

The Fed’s job is difficult. There are long and variable lags when the Fed adjusts interest rates. Typically, it takes six to nine months to see the impact of a rate movement in the economy.  Accurately anticipating movements in both inflation and the labor market is critical. Additionally, there are anticipated inflationary lags on imposed tariffs which continue to be ambiguous.

On both mandates, full employment and price stability, the economy has moved in the right direction over the past three years. The inflation rate is not at the Fed’s target of 2% but has been cut in half. The labor market has weakened but, in historical terms, is still strong.

The Fed voted to leave rates unchanged in their July meeting. However, two of the 12 members dissented from the majority and voted to cut rates. This is the first time in 30 years two members have dissented, indicating differing views within the committee. President Donald Trump has been rather vocal regarding his desire for lower rates and will soon nominate a new Federal Reserve President as Jerome Powell’s term ends in May 2026.

As of Aug. 5, the futures market indicates there is a 64% chance of two rate cuts (25 basis points each) and a 20% chance of three cuts by the end of the calendar year. The probability of a September rate cut jumped from 40% before the most recent jobs report to 85%.

It is safe to say we haven’t crashed. Did we land? Was it soft? What will the next pilot be like?

David Richards is a senior portfolio manager at Commerce Trust. He can be reached at david.richards@commercebank.com.