1. The economy continued to grow, but there are signs that the pace has slowed.
2. The job market remains solid, but perhaps less so.
3. Inflation is still above the Fed’s longer-term goal, although it is easing again.
4. The Federal Reserve expects to start easing later this year, but not yet and by less than it had previously expected.
5. The soft landing appears to be here – but for how long?

A look back at the second quarter, slower growth but no recession (at least not yet):

Real GDP growth slowed substantially in the first quarter, down to a 1.4 percent annualized rate. This was the slowest pace since the second quarter of 2022 and is below most estimates of trend growth. With that diminutive growth, is the long-heralded recession finally about to appear? Probably not.

• “Core” growth (real final sales to private domestic purchasers) edged down only slightly to an annualized rate of 2.6 percent. This was a tad faster than the 4-quarter growth rate of 2.7 percent – a smoothed measure that removes many temporary gyrations in growth.
• The Atlanta Fed’s GDPNow estimate of second quarter real GDP growth is 2.2 percent – far from recessionary and above trend (a likely range of 1.5-2.0 percent).

But even if real GDP growth in the second quarter is stronger than in the first, there are good reasons to believe that the economy is slowing (and it is likely that core GDP growth will be less rapid).

Housing has been the sector that has most taken it on the chin. A lack of supply in the post-Covid period came from the large share of mortgages at or near record low interest rates, and they will be slow to transact. This lack of supply has led to record house prices – and when combined with higher mortgage rates this year, has caused home sales to drop. New home sales for May fell by 11.3 percent to an annualized pace of 619,000 – the second lowest figure since November 2022. Existing home sales (a lagging indicator as it reflects contract closings, rather than contract signings as with new home sales) have declined every month since February. Moreover, the supply situation is unlikely to improve in the near term, with housing starts in May down to the lowest level since June 2020 – as the economy was just beginning to pull out of the Covid recession.

Consumer spending has slowed as well (although slower inflation has played a role), with retail sales (expressed in nominal, not real, terms) down slightly over the past two months. Even adjusting for inflation, May personal consumption expenditures (a broader measure of consumer spending than retail sales) rose by a modest 0.3 percent – after declining in April. With consumer spending roughly two-thirds of all spending in the economy, a slowdown here is sure to bring growth in core GDP down, too.

Business surveys are mixed, suggesting modest overall economic growth. The ISM manufacturing survey slipped to 48.7 percent in May (figures less than 50 indicate contraction), while the ISM services survey rose to 53.8 percent. Taken together, the ISM survey measures imply modest overall growth in the economy. The NFIB Small Business Optimism Index rose a bit in May to 90.5 – but this was the 29^th consecutive month of a below-average reading. Additionally, the NFIB Uncertainty Index climbed to the highest level since November 2020.

Monthly changes in nonfarm payrolls have become more volatile in recent months, but there is little to suggest that there is a decided downward trend. Other data, however, suggest that the job market is slowing and becoming less tight. The U-3 unemployment rate has trended higher this year and reached 4.0 percent in May. While still historically low, this is the highest level since January 2022. Additionally, job openings have been trending lower since March 2022 and at 8.1 million in April they were the fewest since February 2021. Weekly unemployment claims have been edging higher over the past couple of months, and the four-week average (helping to smooth out some of the weekly volatility) is now up to the highest level since early September 2023. Considering these data overall, the job market is slowing modestly, but it is slowing.

A combination of tighter monetary policy, significantly fewer supply constraints, and slower economic growth is bringing inflation lower. While the monthly Consumer Price Index (CPI) readings tend to be volatile, the most recent data (May) showed an increase of less than 0.1 percent. Although this is certainly positive news, the 12-month trend rate has moved within a small range over the past year and in May edged down to 3.3 percent – still well above the Fed’s 2.0 percent longer-term goal. Removing the volatile food and energy components, the core CPI rose by 0.2 percent for the month and the trend rate dropped to 3.4 percent. Unlike the overall CPI, the trend rate in the core CPI has been clearly moving lower since September 2022. The Fed prefers the broader inflation measure from the personal income and spending report. On this basis, the overall PCE price index was unchanged in May, with the trend rate up by 2.6 percent (little changed over the course of this year). The core PCE price index increased by only 0.1 percent in May, with the trend rate slipping also to 2.6 percent. We prefer measures of the central tendency of inflation, such as the Cleveland Fed’s median and trimmed-mean CPI, and both of these measures have dropped sharply in recent months. Still, even these measures remain between 2.5-3.0 percent.

Market expectations of Fed easing have changed significantly over the past year as inflation has abated either more quickly or slowly than hoped and as the Fed’s own predictions of future policy moves have changed. The most recent projections from the members of the Board of Governors and the regional Bank Presidents (from the June FOMC meeting) showed that the median expectation fell from three Fed easing moves to only one for 2024 – offset by expectations of four moves next year compared with only three from the March projections. Financial markets, however, expect two moves this year according to data from the CME Group, with another four or five for next year. The important thing is not that the market and the Fed have slightly different views of how many easing moves the Fed will make this year (two versus one), but that both the Fed and financial markets expect short-term interest rates to be substantially lower by the end of next year.

With inflation moving (perhaps grudgingly) lower and expectations of sharply lower short-term rates by the end of next year, longer-term interest rates have trended lower over the past several months. The yield on the 10-year Treasury note, for example, fell to as low as 4.21 percent earlier in June – the lowest level since late March. Rates have edged higher since then, up to around 4.28 percent – down just a tad from the end of the first quarter.

Prices for broad equity averages have responded positively to a combination of strong earnings, lower interest rates, expectations of even lower interest rates ahead, and reduced fears of a hard landing in the near future. The S&P 500 Index, for example, has seen several record-high closings over the past month. As the quarter nears its close, this key index is up by nearly 16 percent from the start of the year and by more than 23 percent from a year ago.

The updated outlook for 2024: A soft landing for this year looks increasingly likely. But what about 2025?

The Treasury yield curve remains inverted, although less so, and the Conference Board’s Index of Leading Economic Indicators continues to decline. Historically, these two have been excellent predictors of economic decline – but so far, a downturn remains on the distant horizon. Recession odds for 2024 have fallen sharply as we get to mid-year, with underlying economic growth slowing but not close to going negative. The good news is that slower growth is helping to bring inflation down (tighter Fed policy does work), and that should allow the Fed to start easing policy this year (with more easing probable for next year). That will be positive for growth in 2025 and beyond.

As the odds of a recession have declined, the chances that growth will remain strong with inflation remaining well above the Fed’s goal have also dropped. U.S. economic activity has slowed, and it’s not clear what would cause it to reaccelerate. Moreover, there are signs that inflation figures were “inflated” early in the year with residual seasonality not accounted for. This implies that inflation will be a bit lower over the remainder of the year to make up for the higher figures earlier. With inflation moving lower, the real federal funds rate would increase if the Fed left policy unchanged – increasing the probability that the Fed will ease at least once this year. But the Fed is likely to be very cautious in easing so as not to repeat the policy errors of the late-1960s to late-1970s.

Longer-term interest rates should slip in response to growing expectations of Fed easing (and then to actual easing). Typically, long-term interest rates decline by less than short-term rates at the start of easing cycles, and we expect that to occur this time, as well – leading to a less inverted yield curve as 2024 progresses and eventually a positively shaped yield curve again (probably next year).

Continued, if slower, economic growth coupled with easier credit conditions as the Fed eases monetary policy and lower inflation should be supportive for equity markets. Note, however, that we do not have an explicit forecast for equity markets other than to say that those markets will trend higher over time (interrupted by occasional declines, which tend to be bigger when associated with recessions).

This view looks very much like what analysts have been calling a “soft landing” – and that is indeed what we expect for the remainder of this year. And as long as inflation continues to drop to (or close to) the Fed’s longer-term 2.0 percent goal, allowing the Fed to ease some this year and a lot next year, that soft-landing scenario should continue into 2025.

Shocks, economic and geopolitical, could disrupt this very positive outlook. By their nature, shocks are low-probability events (that in hindsight perhaps should have been viewed as having a higher probability) that are not easily forecastable. Among potential shocks could be the results of the U.S. elections in November, changed economic policies that are clearly detrimental to the economy or inflation, expansion of the conflicts in Ukraine and/or the Middle East – and perhaps new conflicts in Southeast Asia. There are certainly many more. While conditions are very positive today, leading to our soft-landing outlook, negative shocks are more likely the farther out you look. And we haven’t even mentioned longer-term problems such as high and rising budget deficits in the US, which may have significant negative impacts eventually, but apparently not today.

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.