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Fed soft landing: What it is and why markets are hoping for one

Yahoo Finance Live’s Jared Blikre breaks down what a soft landing is and how stocks are trading following the Fed's rate hike decision Wednesday.

Video transcript

RACHELLE AKUFFO: Well, hopes of a soft landing pull into view following a more optimistic tone from Fed Chair Jerome Powell. But what would markets look like in this favorable scenario for the US economy? We have our Jared Blikre here to break down the details. Hey, Jared.

JARED BLIKRE: Hi, there. So this is a drinking game, right? Soft landing. We got to explain and break down what this is. So the definition of a soft landing is when the Federal Reserve is noticing that the economy is getting overheated. And in terms of inflation, that has already happened. That was a really big story that started last year, actually the year before. So if the Fed is able to whip inflation without a recession, that is a soft landing.

Now, unemployment, we talk about the Fed's dual mandate here that has to do with stable prices, and that's a problem for the Fed right now, as prices are not stable, and also maximum unemployment-- or maximum employment. And so that's what we're also seeing right now. Now, for the Fed to get inflation under control, it's thinking that it has to get unemployment up-- in other words, people have to lose jobs. And of course, when people lose too many jobs, that leads to a recession.

So the hope is the Fed can make it a little bit more difficult for people to buy some of the things that they want to, but not without losing too many jobs. That would be a soft landing. Has this ever happened, do you think? Guess what? Greenspan's 1994 Fed did that way back when. That would be 29 years ago. So we'll see if it happens again today. But even Powell, if you check out some of the things he said yesterday-- we're going to get into that right now-- may not be Fait accompli.

In fact, he might be saying that the market has already gotten ahead of itself. So his job, and I'm going to be quoting Macro Alf here. Some of these tweets came out yesterday. Powell's main job on Wednesday was to push back against easier financial conditions. What is that? That means rising stocks? Guess what? Stocks have been rising this year. Yields have been moderating, going downward. So financial conditions have been getting easier this year, even though they're still at depressed levels. He didn't push nearly back enough. And so markets are rallying hard in his face.

Now, remember, Neel Kashkari, Fed member, said last year that he doesn't want to see a stock market that's rallying in the face of all this. So that may be a problem. The thing is, Alf is saying, this won't stop unless data comes in very hot. Oh, my goodness. The Fed will turn hawkish again. Or data comes in recessionary-like. Oh, my goodness, this is not a soft landing.

Now let me break that down as well because when it comes to bear markets in recessions or bear markets without recessions, the two are very different. Bear markets without recessions tend to get resolved quickly. And I think that's what the market is betting on right here. But if we do see a recession-- and a lot of indicators are pointing to April and May, not just one, about five or six, if we do get a recession, probably going to go down, revisit those lows in the indices, and also probably exceed them to the downside. So in the meantime, the window for the misplaced soft landing narrative is now extended.

And just one more slide here real quick, this has to do with Powell saying yesterday, we need substantially more evidence to be confident about inflation returning to 2%. And he gets to the heart of the matter. In particular, we want to see core non-housing services inflation running at 4% annualized with no progress there. In fact, he said that could be a problem. They're looking at core non-housing-- core non-housing services.

And what he points to is, yes, it's dropped down from this high of about 11% to 4% right now, but when you look at the composition, it's all in medical care. So that could be a sticky component. And if that's what CPI prints next month and the month after, guess what? Markets are probably going to go down hard. So markets may be a little too buoyant right now. We'll have to see how this resolves, but even Powell not entirely confident in the stock reaction to this.

RACHELLE AKUFFO: Yeah, and that uncertainty really not helping. So investors pretty much running away with the narrative that they need right now. Jared Blikre, thank you for that breakdown. Great stuff.