Recession risks rattle markets but not yet a concern

Disappointing US jobs data has shaken confidence in a soft landing for the world’s largest economy, sending global stock markets lower and raising bets on interest rate cuts.

But investors’ abandonment of the popular yen trade played a big role in the sell-off, complicating the message that asset prices convey about the economic outlook.

No one can say for sure how likely a recession is. Goldman Sachs has raised the odds of a U.S. recession to 25%. JPMorgan Chase sees a 35% chance of a recession before the end of the year.

Here’s what five closely watched market indicators are saying about the risks of a global recession:

Data puzzle

The U.S. unemployment rate jumped to a near three-year high of 4.3% in July amid a sharp slowdown in hiring.

This has fueled recession fears by hitting the trigger point for the “contribute” rule, which has historically shown that a recession is underway when the three-month moving average unemployment rate rises half a percentage point above its lowest level in the previous 12 months.

However, many economists believe the reaction to the data was overdone as the numbers may have been skewed by immigration and Hurricane Beryl. Better-than-expected jobless claims data on Thursday also supported that view, sending stocks higher.

“Payrolls are still growing,” said Dario Perkins, managing director of global economics at consultancy TS Lombard. “If payrolls start to turn negative, that would make me more concerned about a real recession starting.”

The U.S. economy grew at a 2.8% annual rate in the second quarter, double the rate in the first quarter and on par with the pre-pandemic average. Services activity also points to continued growth.

But outside the US, business activity indicators point to faltering growth in the euro area, while China’s recovery remains fragile.

Global economic data is pointing to negative surprises nearing their highest level since mid-2022, according to Citi’s surprise index.

corporate defeat

The MSCI World Stock Index has fallen more than 6% from its record highs hit in July, while the U.S. S&P 500 has lost more than 4% so far in August.

However, analysts say stocks, which are still up about 7% globally this year, are far from signaling a recession.

Goldman Sachs estimates that every additional 10% sell-off in U.S. stocks would reduce growth over the next year by about half a percentage point.

Credit conditions may be more important, analysts say.

They point out that although the risk premium paid by corporate bonds compared to government bonds in Europe and the United States has widened, it has been correcting from historically narrow levels, and the moves have not been pronounced enough to indicate rising recession risks.

The story continues

According to Bank of America, the recession outlook implied by the gap between US investment-grade bonds and Treasury yields is now about half what it was in 2022 and 2023.

cut away

Buoyed by US jobs data and hawkish Fed comments, traders now expect US interest rates to be cut by around 100 basis points by the end of the year.

That’s down from more than 130 basis points earlier this week, but double the roughly 50 basis points expected on July 29. Markets are also pricing in a greater than 50% chance of a large 50 basis point cut in September.

Big banks also added to the cuts the Fed expects this year.

The Fed is likely to cut interest rates three times this year, but given the uncertainty over how economic data will evolve, it is understandable that markets have been pricing in the possibility of further cuts, said Steve Rieder, portfolio manager at Aviva Investors.

Elsewhere, traders see a high chance that the European Central Bank will cut interest rates three more times this year, having seen a less than full chance of a second cut in mid-July.

yield curve

Rate cut bets have sent short-term U.S. Treasury yields lower, and the closely watched portion of the yield curve that tracks the gap between 10-year (ZN=F) and 2-year (2YY=F) Treasury yields turned positive for the first time since July 2022 on Monday.

While an inverted yield curve has historically been seen as a good indicator of an on-the-ground recession, the curve tends to revert to its normal position as a recession approaches.

However, with the curve inverting for a record period during this cycle without a recession, a majority of strategists polled by Reuters earlier this year no longer see it as a reliable indicator of a recession.

The curve has since inverted, standing at minus 5 basis points on Thursday.

Dr. Cooper

Known as “Dr. Copper” for its record as a boom-and-bust indicator, the metal’s slide to a four-and-a-half-month low this week puts it firmly on the recession watch list.

Three-month LME copper prices, which are trading at around $8,750 a metric tonne, have fallen about 20% from a record high in May, reflecting pessimism about the global economic outlook.

Oil prices, another gauge of the health of global demand, are near multi-month lows, but their decline has been limited by concerns that tensions in the Middle East could squeeze supplies from the world’s biggest oil-producing region.

(Reporting by Yoruk Bahceli and Dara Ranasinghe; Editing by Thomas Janowski)