Wall Street has been contemplating three possible scenarios for the U.S. economy: soft landing (moderate economic slowdown); hard landing (recession); or no landing (growth above normal while inflation eases to the Federal Reserve’s target of 2%).

Fed Chair Jerome Powell is striving to curb inflation without crashing the economy, but his balancing act is increasingly untenable. The Fed’s tightening hasn’t cooled particularly hot sectors of the economy, notably employment.

Reminds me of a line in the movie Airplane! A flight attendant asks passengers: “By the way, is there anyone on board who knows how to fly a plane?” Panic ensues.

Wall Street isn’t panicking quite yet, but bearish sentiment is on the rise. Powell’s two-day testimony in Congress this week increased the odds that the U.S. economy will hit the tarmac pretty hard.

Powell made it clear in his remarks on Capitol Hill that the central bank will keep rates higher for longer. Instead of an 0.25% hike at the next meeting of the Federal Open Market Committee (FOMC), the betting now leans toward 0.50%.

“If the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes,” said Powell before the Senate on Tuesday. The next day, he reaffirmed his hawkish stance in front of the House.

Stocks tanked Tuesday, and experienced intraday volatility Wednesday before closing little changed.

Volatility continued Thursday, with the main U.S. stock market indices finishing sharply lower as follows:

• DJIA: -1.66%
• S&P 500: -1.85%
• NASDAQ: -2.05%
• Russell 2000: -2.81%

The 10-year Treasury yield currently hovers near 4%, and the CBOE Volatility Index (VIX), aka “fear index,” has spiked past 22.

When the VIX exceeds 20, investors can expect greater volatility over the next 30 days. This level of the VIX is typically caused by market stress, such as aggressive monetary tightening.

Government payroll numbers for February are scheduled for release Friday morning. Wall Street and the Fed will be watching closely. If the employment report comes in hot…fasten your seatbelts.

On March 9, the Fed released this Federal Reserve Economic Data (FRED) chart that neatly summarizes the inflation dilemma:

The FRED graph above shows the all-items consumer price inflation (CPI) rate (dashed red line), reported by the U.S. Bureau of Labor Statistics, plus two special aggregations of consumer prices:

• The “all items less food and energy” CPI inflation (green line) excludes food and energy prices, two components of the all-items CPI that are the most volatile, and
• The “sticky price” CPI inflation (blue line), which sorts the components of the all-items CPI and categorizes them as either “flexible” or “sticky” (i.e., slow to change).

In addition to sticky inflation and a persistently hawkish Fed, we’re facing the headwind of decelerating earnings growth. For the fourth quarter of 2022, the earnings decline for the S&P 500 is -4.6%, which is below the five-year average earnings growth rate of 14.3% and below the 10-year average growth rate of 8.9%.

The results for Q4 2022 represent the first time the index has reported a year-over-year decline in earnings since Q3 2020 (-5.7%).

Projections for future quarters are negative as well, raising concerns about an earnings recession, which occurs when we’ve witnessed two consecutive quarters of negative profit growth. For Q1 2023 and Q2 2023, analysts are projecting earnings declines of -5.9% and -3.8%, respectively.

The good news is, for Q3 2023 and Q4 2023, analysts are projecting earnings growth of 2.9% and 9.6%, respectively. For calendar year 2023, analysts predict earnings growth of 2.1%.

Shelter from the storm…

When the Fed eventually eases, we’ll see a resurgent economy and stock market. But in the meantime, we’re in for a bout of pain and volatility. Rising rates, sticky inflation, falling earnings, and a full-fledged economic recession loom as near-term threats and could converge into a “perfect storm.”

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John Persinos is the editorial director of Investing Daily.

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