Jerome Powell, the chairman of the Federal Reserve, is not a pilot, but he started talking like one when the economy began to nosedive earlier this year.
Specifically, Powell said he would try to “land the plane softly,” and that “plane” is the U.S. economy. It’s the biggest economy in the world, and with more than 329 million passengers on board, a lot is at stake because unless he sticks that landing, the effects—and an economic ground stop—could be felt worldwide.
The aviation industry in the U.S. contributes $1.8 trillion in total economic activity and supports nearly 11 million jobs—which means it’s 5 percent of the U.S. economy—and as the greater economy goes, it goes too. A series of trends are running into each other, putting us in this precarious position that now requires Powell and the Federal Reserve to flex some muscle.
After overcoming the pandemic (and possibly because of the means it took to do so, i.e.: economic stimulation by the government), the aviation industry—business and commercial—are feeling the full weight of two years of pent-up demand. People are eagerly buying airplanes and traveling, whatever the cost. Moreover, with relaxed border restrictions and COVID policies, this zest to travel is supported by the fact that some people saved a lot of money (personal earnings, stimulus and unemployment checks) during the pandemic. In fact, at the early pandemic high in April 2020, people saved up to 33 percent of their income, according to the U.S. Bureau of Economic Analysis—but now, they’re spending it aggressively, only saving 4 percent of their income, as of April 2022.
Additionally, the pre-pandemic business environment that allowed the aviation industry to expand and experience a compounding decade of growing revenues means that there was even more money in the system.
But the economic winds shifted, and plenty of factors are at play. The push to get “back to normal” means that demand has outweighed supply, causing the prices of goods and services—tracked through the Department of Labor’s Consumer Price Index—to climb to the highest they have been in 41 years. The supply of various goods, commodities such as fuel, and services, are also constrained by the loss of Russia from the global economic engine, because of sanctions imposed on the country following its invasion of Ukraine. China, the other superpower, is still dealing with pandemic lockdowns.
The convergence of these trends has caused the price inflation we’ve all witnessed, pushing the economy off its centerline unless the Federal Reserve, piloted by Chairman Powell, can navigate the “soft landing” its hoping for.
“The reality is there is a fairly elevated risk of recession.”
LaVaughn Henry, former senior economist on the Council of Economic Advisers
However, it appears this soft landing is getting trickier to achieve. In June, during a Senate Banking Committee hearing, Powell conceded to the board that to cool consumer demand and encourage the inflation rate back to a normal level (2 percent versus 8.6 percent in June), the Federal Reserve would have to continue raising interest rates, so that people would stop spending. Already last week, the Fed announced its third consecutive 0.75 percent interest rate hike—bumping the federal funds rate to a range of 3.0 to 3.25 percent—in an attempt to slow inflation.
Scenario 1: Higher Inflation
Bijan Vasigh, an aviation consultant and professor of economics and finance at Embry-Riddle Aeronautical University in Daytona Beach, Florida, said the probability that there could be a recession is higher than not, and he pointed to the underlying causes of the high inflation as the reason why the government needs to intervene. However, he explains that when the government raises interest rates, the cost of doing business increases. Lower revenues means businesses could ultimately be forced to reduce headcount, driving up unemployment.
“The government cannot control both inflation and unemployment simultaneously,” Vasigh said. “They would have to choose one at the cost of the other—if you want to control inflation, that will come at the cost of higher unemployment.”
At the same time, airlines have been ramping up hiring across their workforce, especially pilots, to meet the travel demand, even with capacity still not back to the pre-pandemic level. When FLYING asked Vasigh in June if a recession might prompt layoffs in the near future, he said, maybe not. That’s because the airlines are grappling with a real shortage of pilots and mechanics instead of a frothy workforce.
“Right now, you can see that airlines have a shortage of pilots because at the beginning of the pandemic, when airlines tried to improve their financial position, they offered senior pilots incentives to retire—this is why we’re seeing a significant number of cancellations,” Vasigh explained, “but right now, the airlines, having lost their manpower, are going back to the drawing board.”
In other words, as Delta Air Lines (NYSE: DAL) CEO Ed Bastian explained in an April earnings call, customers’ willingness to spend, even with elevated ticket prices, means that airlines are one of the few businesses that aren’t seeing an economic slowdown, just yet. In fact, they are now playing catch-up because travel has become less discretionary.
“Consumers have not been traveling over the last two years. So, this is a category that they’re prioritizing,” Bastian said. “People are looking for experiences. You’re seeing a significant shift from goods and retail into experiences and services.”
However, while that may be the case for the airlines, would other sectors of the industry—like business aviation and even flight schools—see the same enduring demand?
Higher inflation has ultimately meant more revenue for business aviation, and particularly companies that can pass their expenses on to customers. This revenue allows a company to own and operate a business jet, for example, so a recession could impact that capability. It could also make it more difficult for businesses to purchase aircraft, slowing the growth that side of the market benefited from during the pandemic.
The case is different for flight schools and students. Inflated fuel prices now mean that the cost of flight training is creeping up, and prospective pilots still have to train—and spend and borrow more money to complete training. On the one hand, for the health of the economy, the country needs inflation to decrease; but as interest rates rise and loans become more expensive or harder to get, it will be progressively more challenging for student pilots to train—which could intensify the workforce shortage.
Scenario Two: Raising Interest Rates
LaVaughn Henry is a former senior economist on the Council of Economic Advisers (CEA). This group directly advises the Biden Administration objectively on economic forces in play. In an interview with FLYING in June, Henry pointed to Boeing’s 2021-2040 Commercial Market Outlook, which echoes that the long-term positives for aviation remain strong. Moreover, he said, it is essential to consider the news of a recession with nuance.
“When The Federal Reserve talks about a recession, they’re talking about the broad economy, not necessarily sectoral,” Henry said, which could mean that the aviation industry at large could weather a downturn.
However, Henry pointed to a May 2022 report by the National Association for Business Economics (NABE), in which the board of senior economists said there was now more than a 25 percent chance of a recession within the next 12 months.
“The reality is there is a fairly elevated risk of recession. Yet, few are seeing the risk of a recession as inevitable—because, in the fundamentals of the economy, there are many strong factors,” Henry said. He points to strong employment levels, worker demand, and wage growth. The flip side is the inflation this has caused. So, Henry said, “we do have headwinds against us.” That’s because the government will need to slow the economy down without causing a recession.
“It’s an issue of how much pressure can the economy take with respect to higher interest rates before demand drops off, so much that that would put us in a recession,” Henry explained. “Higher rates cause credit to become more costly, which hurts business demand to invest or consumer demand to borrow. These higher rates help drive down broad market demand and therefore help slow the economy.”
Worse, Henry said the government’s tweaks could have long-lasting effects, so it would be essential for them to tread cautiously.
“The fear that the markets have is that the Fed will overreact. It takes so long for monetary policy to adjust people’s behavior. So, we wouldn’t know whether the fed overshot or undershot for months.”
So, where does that leave the aviation industry? Chairman Powell told lawmakers in June that a soft landing will now be “very challenging.”
Where Are We Now?
Since then, the Federal Reserve has struggled to tame the economy as the still high inflation rate of 8.3 percent reported in August means the Fed has to keep tightening its belt, which means raising interest rates. Following the latest increase, last week, the Federal Reserve rate is now at its highest (3.25 percent) since 2008, and unless consumer spending cools, the Fed has committed to raising rates even higher.
According to a September CNBC Fed survey of economists and analysts, respondents said there was a 52 percent chance of the U.S. entering into a recession over the next 12 months. Moreover, CNBC reported that Steve Hanke, a professor of applied economics at Johns Hopkins University, placed the probability of a recession at 80 percent.
That soft landing Powell wanted now seems more elusive than ever.
