We continue to expect a US recession starting in Q2, though a later start date would not surprise. 

Because the market has become more optimistic about a soft landing we outline the necessary conditions for this to occur. 

Domestically generated inflation needs to show clearer signs of abating. Core goods prices have declined of late as demand-supply imbalances have corrected. But underlying services inflation remains sticky. 

Excess labour demand would have to be eliminated through vacancy rather than job destruction. This requires a large improvement in the labour market matching function that is not yet evident. 

Alternatively, a significant improvement in labour supply would reduce the need for rebalancing to occur through labour demand, but labour supply measures have continued to disappoint since the pandemic. 

Labour cost growth – adjusted for productivity – would also need to decline significantly from current levels. Though most measures of wage growth have moderated from their peaks, the magnitude has not been large enough to be consistent with price stability. 

The lagged impact of policy tightening would also need to be both modest and short, and any renewed tightening avoided. While financial conditions have eased recently, we think markets may be misreading the Fed’s reaction function.