By Yoruk Bahceli and Dhara Ranasinghe
(Reuters) – Disappointing U.S. employment figures have shaken confidence in a soft landing for the world’s largest economy, sending global stock markets tumbling and boosting bets on interest rate cuts.
But investors’ abandonment of a popular yen carry trade played a major role in the sell-off, complicating the message from asset prices about the economic outlook.
The chance of a recession is anyone’s guess. Goldman Sachs has raised the chance of a recession in the US to 25%. JPMorgan sees a 35% chance of a recession before the end of the year.
Here’s what five closely watched market indicators say about global recession risks:
1/ PUZZLE DATA
The US unemployment rate rose to nearly 4.3% in July, the highest level in three years, amid a significant slowdown in employment.
Fears of a recession were fueled by the reaching of a threshold for the ‘Sahm rule’. Historically, a recession is declared when the three-month average unemployment rate is half a percentage point above the low of the previous twelve months.
Still, many economists believe the reaction to the data was overblown, with the numbers potentially skewed by immigration and Hurricane Beryl. Better-than-expected jobless claims on Thursday also supported that view, sending stocks higher.
“Wages are still growing. If you see salaries going negative, I would be much more concerned that we are entering a real recession,” said Dario Perkins, managing director, global macro at consultancy TS Lombard.
The U.S. economy grew at an annualized rate of 2.8% in the second quarter, double the first quarter and equal to the pre-pandemic average. Services activity also points to continued growth.
Outside the United States, however, economic activity indicators point to slowing growth in the eurozone, while the recovery in China remains fragile.
Citi’s surprise index shows negative surprises in global economic data, which is at its highest level since mid-2022.
2/ COMPANY ROUTE
MSCI’s global stock index has fallen more than 6% from July’s record highs, while the US S&P 500 has fallen more than 4% so far in August.
However, analysts believe that stock prices, which have still risen around 7% globally this year, are still far from pointing to a recession.
Goldman Sachs estimates that each additional 10% sell-off in the US stock market would reduce growth over the next year by just under half a percentage point.
Analysts say credit conditions could prove more important.
They note that while the risk premium paid by corporate bonds over government bonds in Europe and the United States has increased, it is correcting from historically low levels and developments are not yet clear enough to suggest that recession risk is high.
According to BofA, recession expectations stemming from the spread between U.S. investment-grade bond yields and U.S. Treasury yields are about half as high as they were in 2022-23.
3/ CUT AWAY
Spurred on by US jobs figures and dovish policy from the Federal Reserve, traders are now pricing in a cut in US interest rates of 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 more than 50% chance of a major rate cut of 50 basis points in September.
Major banks have also expanded the rate cuts the Fed expects this year.
According to Steve Ryder, portfolio manager at Aviva Investors, the Fed is likely to cut rates three times this year. However, given the uncertainty surrounding economic data, it is understandable that markets are pricing in the likelihood of more cuts.
Elsewhere, traders are estimating a high probability that the European Central Bank will cut interest rates three more times this year. In mid-July, the likelihood of a second cut was not yet fully assessed.
4/ YIELD CURVE
Bets on rate cuts have pushed yields on short-dated U.S. Treasuries lower. The closely watched part of the yield curve that tracks the difference between 10-year and 2-year Treasury yields turned positive on Monday for the first time since July 2022.
While a yield curve inversion has historically been seen as a good predictor of an impending recession, the curve tends to return to normal as a recession approaches.
But because the curve has been inverted for so long this cycle and there is no recession in sight, a majority of strategists surveyed by Reuters earlier this year no longer consider it a reliable indicator of a recession.
Since then, the curve has inverted again and stood at -5 basis points on Thursday.
5/ DR COPPER
The metal is known as “Dr. Copper” for its reputation as an indicator of economic growth and economic downturn. The metal’s fall to a 4.5-month low this week puts it firmly on the recession list.
Copper prices on the London Metal Exchange are currently trading around $8,750 per tonne, down around 20% from their record high in May, reflecting pessimism about the global economic outlook.
Oil prices, another barometer of the health of global demand, are at near-monthly lows. But their decline has been limited by concerns that tensions in the Middle East could curtail supplies from the largest oil-producing region.
(Reporting by Yoruk Bahceli and Dhara Ranasinghe; Editing by Tomasz Janowski)
