In the wake of the Federal Reserve’s (Fed’s) hefty half-point rate cut in September, many market observers jumped on the “no landing” bandwagon. Unlike the previously favored “soft landing” scenario, “no landing” suggests a more upbeat outlook. It assumes resilient growth, easing monetary policy, moderating inflation and a stable labor market.

Recent bond market movements have complicated this view. After dropping to year-to-date lows in mid-September, U.S. Treasury yields spiked through October on upbeat economic data and expectations for a growing federal deficit. For example, the 10-year U.S. Treasury yield jumped 64 basis points from September 16 through October 29.

It’s our view that this Goldilocks-type scenario remains unlikely. Following a modest slowdown in third-quarter gross domestic product (GDP) to 2.8%, from 3% in the second quarter, we expect the economy to slow further. High interest rates, persistent above-target inflation and weaker labor market data will likely weigh on the economy, particularly from the consumers’ point of view.

We believe this environment continues to underscore the role high-quality equity and fixed-income securities may play in investor portfolios.

Consumer Pressures Are Rising

In our view, the Fed’s extended period of restrictive policy will ultimately take a toll on consumers. As we’ve previously discussed, consumers have broadly depleted their excess savings. Therefore, maintaining recent robust spending patterns would likely require borrowing at today’s still-high interest rates:

• The average 30-year fixed mortgage rate was 6.9% as of October 30, 2024, per Bankrate.com.

• The overall average auto loan interest rate was 6.8% for new cars as of October 11, 2024, according to MarketWatch.

• The median average credit card interest rate was 25% in October, according to Investopedia.com.

While Fed rate cuts typically influence consumer lending rates, the process takes time, and the correlation isn’t direct. Additionally, other factors, including supply and demand, credit scores and Treasury market moves, affect consumer loan rates.

Inflation Pressures Persist

Furthermore, longer-term inflation expectations, which have been on the rise, also affect longer-term interest rates, which typically drive mortgage and other consumer lending rates higher. We believe several factors, including slower but still positive economic growth, soaring federal debt and political uncertainty, may keep long-term inflation expectations elevated.

Meanwhile, some measures of current inflation, which remains above the Fed’s target, have moderated, and others have inched higher. The annual core Personal Consumption Expenditures price index, the Fed’s favorite gauge, increased in July and August and held steady at 2.7% in September. The monthly gain of 0.3% in September was the largest increase in five months.

The annual core Consumer Price Index (CPI) inched up in September to 3.3%, propelled by higher shelter and transportation services costs. Meanwhile, overall inflation, as measured by headline CPI, slowed for the sixth straight month in September to an annual pace of 2.4%. However, from a longer-term perspective, inflation’s cumulative effects have been stifling: Since January 2021, average consumer prices (headline CPI) are up 21%.

Labor Market Indicators Signal a Potential Economic Slowdown

We see additional consumer pressures mounting in the job market, where some recent data point to a potential slowdown. For example, U.S. employers announced nearly 73,000 job cuts in September, up 53% from the prior year.¹ Year to date, the number of total job cuts is up 1% from the same period in 2023.

Elsewhere, the number of U.S. job openings fell by 418,000 from August to September, dropping to the lowest level since January 2021.² The government also revised lower the number of job openings in August. Continuing jobless claims, a gauge of the number of people receiving unemployment benefits, spiked to a three-year high in October.

Slower U.S. Economic Growth Should Emerge in the Coming Months

We believe an economic shift is likely underway and eventually will stifle GDP. For these reasons, we put the odds of a slowdown (below-trend growth or recession) sharply higher than other possibilities.

• Slowdown: We believe growth will slow to a below-trend pace (flat to slightly positive) for several quarters. We also believe a recession remains possible, though not as likely as anemic growth. We expect the Fed to continue cutting rates into mid-2025.

• Overheated Economy: We believe there’s a slim chance of growth surprising to the upside with inflation hovering above target and financial conditions remaining tight.

• Goldilocks: In our view, a scenario in which inflation drops to 2% or lower, the Fed continues easing and growth persists at trend or above-trend levels seems like a longshot.

What Would a Slowdown Scenario Mean for Investors?

As the economy slows, U.S. Treasury yields will likely fall. We also expect credit spreads to widen. While inflation should moderate, we still expect core inflation (excludes food and energy prices) to remain higher than the Fed’s 2% target in the short term due to:

• Continued pressure on the services component of the CPI, mainly from wages and elevated shelter (rent and owner’s equivalent rent), transportation and medical costs.

• The ongoing repositioning and rerouting of global supply chains, rising shipping costs and potential tariffs.

• Global political tensions and record-high deficits.

What Would an Overheated Economy Mean for Investors?

If economic growth surprises to the upside, inflation would likely remain above the Fed’s target. A growth surprise scenario could also trigger additional Fed tightening.

What Would a Goldilocks Scenario Mean for Investors?

If inflation quickly drops to target or below-target levels and the Fed eases monetary policy, Treasury market volatility will likely subside. We would expect Treasury yields and mortgage rates to decline, credit spreads to tighten and the economy to expand at trend or above-trend rates.

What a Slowing Economy May Mean for Portfolio Allocations

In our view, maintaining a broadly diversified portfolio is the appropriate antidote for a changing economic backdrop. However, certain investment characteristics deserve consideration in a slowing economy.

For example, given the uncertain growth outlook, we believe bond investors should consider tactical allocations to interest rate and credit sensitivity. Remaining nimble may be the best approach for credit-sensitive securities, offering opportunities to capture yield advantages across a range of economic scenarios. And because we expect inflation expectations to remain volatile, inflation-linked strategies may offer value.

Additionally, we believe focusing on quality in equities and real assets will be crucial over the next several months. In our view, companies that can pass on costs to consumers should be able to protect margins from wage and input cost inflation.

More broadly, emphasizing quality may also help investors navigate a weak or flat economy. In general, quality companies — those with healthy balance sheets, higher profitability and more stable cash flows — have tended to offer attractive performance potential in economic downturns.