The S&P 500 experienced a dramatic 3% decline on Monday, marking its most significant drop in nearly two years. This selloff was primarily driven by heightened recession fears following weaker-than-expected job data released last Friday, raising concerns about the Federal Reserve’s ability to achieve a “soft landing.”
Friday’s federal data showed a sharp increase in the U.S. unemployment rate, sparking investor worries about a potential “hard landing”—a scenario where the Fed’s interest rate policies fail to curb inflation without triggering an economic downturn. Despite these fears, some economists maintain that a soft landing remains a plausible outcome.
Diverging Opinions on Economic Outlook
Mark Zandi, chief economist at Moody’s, remains optimistic, stating that a soft landing is still the most likely scenario. Jay Bryson, chief economist at Wells Fargo Economics, also supports this view but acknowledges the validity of recession concerns given recent signs of economic fragility.
Both Zandi and Bryson emphasize that for a soft landing to materialize, the Fed will need to start cutting interest rates soon. Prolonged high borrowing costs could significantly increase the risk of a recession.
The Trigger: Disappointing Job Data
The catalyst for the recent market turmoil was the latest monthly jobs report from the Bureau of Labor Statistics, which showed an increase in the unemployment rate to 4.3% in July, up from 4.1% in June and 3.5% a year ago. While a 4.3% jobless rate is historically low, its steady rise over the past year triggered the Sahm rule—a recession indicator that signals a recession when the three-month moving average of the unemployment rate is at least 0.5 percentage points higher than its low in the previous 12 months.
Goldman Sachs reacted by raising its recession forecast from 15% to 25%. Zandi estimates the likelihood of a recession within the next year at about 33%, while Bryson places it between 30% and 40%.
Questioning the Sahm Rule’s Accuracy
Zandi suggests that the Sahm rule may not be an accurate recession indicator in the current economic cycle due to the unique factors influencing the unemployment rate. Unlike past triggers driven by weakening demand for workers, the recent rise in unemployment is attributed to an increase in labor supply, with more Americans entering the job market and looking for work.
Bryson notes that the labor force grew by 420,000 people in July, indicating that businesses are still retaining employees. For instance, the layoff rate was 0.9% in June, the lowest on record since 2000.
Mixed Signals in the Labor Market
Despite these positive signs, there are troubling indicators of a cooling labor market. Hiring rates have slowed below pre-pandemic levels, and unemployment claims are gradually increasing. The unemployment rate is at its highest since late 2021, prompting economists to express caution.
Nick Bunker, economic research director for North America at Indeed, highlighted in a recent memo that while there were yellow flags in labor market data over the past few months, these flags are now turning red.
Positive Economic Indicators
On a brighter note, consumer spending, which accounts for about two-thirds of the U.S. economy, remains robust. This resilience in consumer spending is crucial for economic stability. Additionally, the overall financial health of households is relatively strong, and the Fed is expected to start cutting interest rates soon, which could alleviate some economic pressure.
Bryson reassures that the current situation is not as dire as past economic crises like September 2008 or March 2020. However, signs of economic weakening are becoming more evident, and close monitoring is essential.
Key Takeaways for Traders and Investors
- Market Volatility: The recent market selloff underscores the current volatility driven by recession fears.
- Fed’s Role: The Federal Reserve’s upcoming decisions on interest rates will be critical in determining the economic trajectory.
- Labor Market Dynamics: While the job market shows mixed signals, the increase in labor supply offers a different context compared to past recession indicators.
- Consumer Spending: Strong consumer spending remains a vital support for the economy.
- Economic Health: Despite some red flags, the overall economic fundamentals suggest a resilient economy.
Conclusion
Traders and investors should stay vigilant and prepared for further market fluctuations as economic indicators evolve. While the likelihood of a recession has increased, a soft landing remains a possibility if the Federal Reserve adjusts its policies appropriately. Monitoring key economic data and the Fed’s actions will be crucial in navigating the uncertain market environment.
