Higher-for-longer interest rates are unlikely to push the US off course for a soft landing, but stubborn inflation and high interest rates are making for something of a murky picture of the nation's overall economic health.

Inflation has significantly cooled and the labor market continues to add jobs at a much faster pace than before the COVID-19 pandemic. But while inflation is down from its peak in 2022, it remains above the US Federal Reserve's 2% benchmark, and the Fed looks poised to keep interest rates at their highest levels in decades for months to come.

Worries over the effects of high mortgage rates, rising debt delinquencies and uneven gains across income groups are painting a perplexing economic picture. Monetary policymakers managed to push interest rates up without plunging the US into a recession, but the economic tea leaves of this recovery are proving difficult to read.

"In today's post-pandemic economy, the issue is not confusing a gradual cooling and normalization with weakness and recession," Mike Skordeles, head of US economics at Truist Bank, said in an interview.

Softening economy

No official definition of a soft landing exists and policymakers are reluctant to put a finer point on just what the term means. Treasury Secretary Janet Yellen in January said the economy was on track for a soft landing after a solid December 2023 jobs report and a string of inflation reports showing price growth had slowed sharply.

Fed Chair Jerome Powell more recently, however, told Congress that the rate-setting agency would make no such call.

"I don't think by us, no," Powell told Congress members in March. "We are just going to keep our heads down and do our jobs and try to deliver what the public is expecting from us. We wouldn't be declaring victory like that."

Certain hallmarks are generally understood to be indicative of a soft landing scenario following a rate hike cycle.

"In a soft landing, GDP growth remains positive, but below potential, leading to a gradual upward drift in the unemployment rate, a convergence of inflation to the Fed's 2% objective and an easing of Fed policy," said Ben Herzon, senior US economist at S&P Global Market Intelligence.

The US economy has so far steered well clear of a recession. Market Intelligence economists expect US GDP to grow by 2.49% in 2024, slightly below the 2.54% growth registered in 2023.

The US unemployment rate has remained below 4% — widely regarded as maximum employment — since January 2022. Similarly, job openings have retreated from a peak in March 2022 but remain above pre-pandemic levels.

"A soft landing means the economy is still growing, there are still jobs being created each month, but the jobless rate may be gently rising. And people are socking away some of their hard-earned income into savings," said Jennifer Lee, senior economist at BMO Capital Markets.

The personal saving rate has shown some signs of weakness in the face of high interest rates and the rising cost of living, dropping from 5.3% in May 2023 to 3.2% in March 2024. Between 2013 and 2019, US consumers were able to save between 5% and 7% of their disposable personal income.

Consumer checkup

US consumers are likely to withstand higher-for-longer interest rates in the near term, said Skordeles with Truist Bank.

"Consumers are less sensitive to interest rates today than they have been in prior periods. The biggest reason for that are homes and home mortgages," Skordeles said. "At least for the foreseeable future, most people won’t be impacted by the new, higher mortgages. The same is true for auto loans, only a small percentage is out buying a new car or home on an annual basis."

US retail sales, an indicator of consumer spending patterns, were flat in April from March as Americans cut back their discretionary spending. Still, spending is at an all-time high.

"It's unclear how long the US economy could withstand the current level of interest rates, because it's unclear exactly how restrictive the current stance of policy is," said Herzon with Market Intelligence. "It is restrictive, but not exceptionally so."

Disproportionate effects on lower-income households, imbalance in the housing market and rising debt delinquency rates suggest the Fed may have to adjust its monetary policy approach.

"While overall economic activity and labor market conditions are robust, the Fed cannot ignore the fact that its higher for longer stance is not working for everyone and may have to fine-tune its monetary policy to bring about a soft landing," said Venkat Veeramani, chief economist at Wintrust Financial Corp. "Otherwise, the Fed risks pushing the US economy into a recession or a stagflation."

Rate roadmap

US consumers may not have to wait much longer for some respite, even if some economic indicators fail to fully meet the Fed's expectations.

"The door is open, if things continue the way they're going, for them to cut rates a little bit, which I think gives a path toward a soft landing and puts off a further slowdown," said Skordeles with Truist Bank.

The majority of the futures market expects the earliest rate cut to occur at the September Fed meeting, according to the CME FedWatch Tool. Fed officials, meanwhile, are debating whether their efforts have been effective, particularly as markets are rallying despite higher rates.

The Fed is unlikely to adjust its 2% inflation goal even if price growth remains elevated in the near term.

"If the Fed is able to meet its dual mandate targets while preventing the real GDP growth rate from falling significantly below 2.0% and maintain those macroeconomic conditions for a reasonable amount of time, an argument can be made that a soft landing has been achieved," said Veeramani with Wintrust.