Disappointing US jobs data shook hopes of a soft landing for the world’s largest economy, sent global stock markets tumbling and heightened the race for interest rate cuts.
But as investors abandoned the popular yen carry trade, complicating the news from asset prices from an economic perspective, the sell-off played a large role.
The likelihood of a recession is anyone’s guess. Goldman Sachs has raised the US economic recession to 25%. JPMorgan ( JPM ) sees a 35% chance of one launching before the end of the year.
Here’s what five closely watched market indicators say about global recession risks:
Date puzzle
The U.S. unemployment rate hit a three-year high of 4.3% in July amid a marked slowdown in hiring.
It fueled recession fears by reaching the trigger point of “Sahm’s Law,” which historically shows that a recession exists when the three-month average unemployment rate is more than half a percentage point higher than the previous 12-month low.
However, many economists believe the reaction to the data is overblown as the numbers could be 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. If you start to see wages turning negative, that makes me very concerned that a real recession is starting,” said Dario Perkins, managing director of global macro at DS Lombard.
The U.S. economy grew 2.8% on an annualized basis in the second quarter, more than double the first-quarter rate and on par with the pre-pandemic average. Services activity also points to continued growth.
Beyond the US, however, business activity indicators point to a slowdown in euro zone growth, while China’s recovery remains weak.
Citi’s surprise index shows that global economic data from mid-2022 will deliver the highest proportion of negative surprises.
Corporate failure
MSCI’s global stock index is down more than 6% from a record peak in July, while the US S&P 500 (^GSPC) has lost more than 4% so far in August.
However, analysts think stocks, which are up 7% globally this year, are far from showing a slowdown.
Goldman Sachs estimates that every 10% selloff in U.S. stocks will reduce growth next year by less than half a percentage point.
Credit conditions may prove more critical, analysts say.
They note that while the risk premium corporate bonds pay over government bonds in Europe and the US has widened, it has been recovering from historically tight levels, and the moves are not yet pronounced enough to suggest recession risks are high.
Recession expectations, as indicated by the gap between U.S. investment-grade bond and Treasury yields, will more than halve in 2022-2023, BofA said.
Cut it out
Buoyed by U.S. jobs data and a dovish-sounding Federal Reserve, traders have now cut U.S. rates by about 100 basis points before the end of the year.
It fell to 130 bps earlier this week, but was roughly double the 50 bps expected on July 29. Markets have a more than 50% chance of a September 50 bps cut.
Major banks have also added to the central bank cuts they expect this year.
Steve Ryder, portfolio manager at Aviva Investors, said the central bank is likely to cut rates three times this year, but given the uncertainty about how economic data will shape up, markets are understandably pricing in the likelihood of further cuts.
Elsewhere, traders see a high chance of three more European Central Bank rate cuts this year, with less than a full chance of a second cut in mid-July.
yield curve
The rate cut race pushed low-dated US Treasury yields lower, and the closely watched portion of the yield curve that tracks the gap between the 10-year (ZN=F) and 2-year (2YY=F), Treasury yields turned positive. Monday for the first time since July 2022.
While a yield curve inversion has historically been seen as a good predictor of a recession on the horizon, the curve tends to return to normal as a recession approaches.
However, as the curve of the cycle has inverted for a record period, a recession has not occurred, and most strategists polled by Reuters earlier this year did not see this as a reliable recession indicator.
The curve inverted on Thursday, standing at minus 5 basis points.
Dr. Copper
Known as “Dr. Copper,” its track record is a boom-bust indicator, and the metal’s fall to a 4-1/2-month low this week is firmly on the recession watch list.
Trading around $8,750 a metric ton, three-month London Metal Exchange copper prices fell about 20% from a peak in May, reflecting pessimism about the global economic outlook.
Oil prices, another barometer of the health of global demand, are near multi-month lows. But their fall has been limited by concerns that Middle East tensions could squeeze supplies from the largest oil-producing region.
(Reporting by Yoruk Bahceli and Tara Ranasinghe; Editing by Thomas Janowski)
