There Are Three Paths for the Economy. Only One Is Good.

Economists pride themselves on making reasonably accurate predictions about the economy. Or at the very least, some well-informed guesses about where it’s going.

Right now, I find myself in the unsettling position of holding not one, but three distinct characterizations of the future of the U.S. economy. Each carries different implications for politicians and policy, for corporations, and for you as an investor. But together, they suggest that we must be prepared to navigate an in-between economic existence for the next few years.

The good news is that our economy has learned how to take a punch, again and again: We have an impressively flexible and resilient system that has navigated an extraordinary series of shocks over the past six years. Despite the pandemic, energy price spikes from the Ukraine and Iran conflicts, and tariff uncertainties, the United States has maintained globally enviable growth. At the same time, we’ve avoided a rerun of the damaging 2022 inflation surge. The Federal Reserve on Wednesday signaled that it’s still on inflation duty, raising the benchmark interest rate by 25 basis points, in what it characterized as a strengthening economy.

This America is a picture of stable equilibrium, in which powerful forces allow the economy to bend without breaking, then revert to the mean — back to where we started. Each shock has had only temporary and reversible effects. This deep consensus, held by Wall Street in particular, explains why investors have been eager to “fade the shocks” and why wealth managers overwhelmingly advise remaining fully invested in equities and bonds. Similarly, policymakers urge staying the course, arguing that no fundamental recalibration is required. You might criticize that pose as a head-in-the-sand strategy, but so far it’s been golden for investors.

The second view of the economy is less rosy. It focuses on a cluster of numbers that have been heading in a disruptive direction: This month, the 10-year Treasury yield broke 5 percent, increasing the cost of servicing our $40 trillion national debt; the $4.37 per gallon average cost of gasoline is draining pocketbooks; and mortgage rates are now at 7 percent, aggravating housing stress. Geoeconomic frictions, such as President Trump’s trade war with Canada, add to the pressures.

In this more unstable version of the economy, investors would be wise to rotate out of weaker assets such as high-yield bonds and into companies with rock-solid balance sheets, pricing power and good management. For policymakers, the emphasis ought to be on containment — playing both offense and defense. They need to prevent these imbalances from intensifying impediments to growth such as high borrowing costs that undermine an already shaky housing market, worsen the fiscal outlook and increase the risks to financial stability.