Will the U.S. economy be able to beat inflation without going into a recession?
That may be the question investors are asking themselves as more economic data is pointing to a softening economy.
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Recession fears started to percolate in early August, when July jobs data showed the unemployment rate growing to 4.3%. The increase in unemployment triggered the recession-indicating Sahm rule and a deep stock-market selloff over the next two trading days.
“The unemployment rate is increasingly more of a watch point for investors,” Matt Stucky, chief portfolio manager of equities at Northwestern Mutual Wealth Management, told MarketWatch.
Although the market was able to bounce back from those losses, investors have been extra sensitive to weak economic data and talk about an upcoming recession.
This week, more data showed recession risks were increasing.
On Tuesday, the Institute for Supply Management’s manufacturing index reported its fifth straight month in negative territory, signaling that the manufacturing sector was in a deep slump. That spooked investors. The Dow Jones Industrial Average DJIA fell 1.5% that day, while the S&P 500 SPX declined 2.1% and the Nasdaq Composite COMP dropped 3.3%.
On Thursday, ADP data showed that 99,000 jobs were added in August. That was a drop compared to the 111,000 jobs added in July, pointing to a slowdown in hiring. It was the slowest monthly job growth seen since early 2021.
All this is building up to the crescendo that is Friday’s U.S. employment report. Remember, it was the employment report released in early August that sparked a market selloff. Wall Street consensus estimates the August unemployment rate at 4.2%, according to FactSet data. If the unemployment rate comes in higher than expected, it could lead to a negative reaction by markets. But even if it doesn’t, investors still may still be on edge.
“Friday has all the makings of an exciting morning, as the market digests the August employment report heading into the September 17-18th FOMC meeting,” Joe Davis, Vanguard’s global chief economist, wrote in a note. “We expect headline job growth will be modestly encouraging, but acknowledge supply-driven volatility in the unemployment rate will likely decide the magnitude of September’s rate cut.”
As mentioned in Fed Chair Jerome Powell’s Jackson Hole speech last month, the Fed will be paying close attention to the U.S. labor market when determining monetary policy. While a Fed rate cut could boost the economy, some people are nervous about the reasons behind a cut — whether it means high inflation is in the rearview mirror or whether the economy needs lower rates to avoid a recession.
“Since rate cuts have become a near certainty, we’ve entered a ‘bad news is bad’ environment. The danger in really bad news is that even if the Fed is prepared to react aggressively, it might be too late to stave off real economic weakness,” Interactive Brokers IBKR chief strategist Steve Sosnick wrote in a note.
The Fed Beige Book — which monitors anecdotal information on current economic conditions — reported Wednesday that economic activity grew slightly across three Fed districts and stayed flat or declined in nine districts. In the previous report, only five districts reported flat or declining activity. The recent report also saw consumer spending and manufacturing activity decline in most districts.
Many companies’ second-quarter earnings have shown this weakness from consumers, especially from lower-income households.
“As we have seen for several quarters now, demand from Family Dollar’s core lower-income customer remains weak,” Dollar Tree Inc.’s DLTR Chief Operating Officer Michael Creedon said in an earnings call on Wednesday, according to an AlphaSense transcript.
Shares of the discount retailer closed 7.7% higher Thursday, but are still lower by more than 50% on the year so far, according to FactSet.
“In our view, the Beige Book suggests that the economy is already growing at a below-trend pace and that recession risks are rising, in line with this week’s weak ISM Manufacturing PMI report and JOLTS data, which showed a further decline in job openings,” Brian Rose, senior U.S. economist at UBS Global Wealth Management, wrote in a note.
According to Rose, UBS still expects the economy to pull off its soft landing, but recession risks are growing.
All this data shows that the economy may be in a weird place. The economy is still growing, but it’s doing so at a slower pace than before, and it’s this deceleration that has investors worried. Will this momentum continue into a recession, or is this just indicative of the soft landing? It’ll take more data to answer that definitively.
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