Wall Street recession fears fueled by patchy US economic data

Investor worries about the overheating U.S. economy are giving way to recessionary jitters as analysts fear the Federal Reserve could stifle growth with its rapid monetary policy tightening.

Markets are aggressively pricing in Fed rate hikes in the coming months, while signaling expectations that the central bank will change course next year and start cutting rates.

“We’ve seen the consumer squeezed by the rising cost of living and by monetary policy, which could lead to a consumer-led recession,” said Erin Browne, portfolio manager at Pimco.

Economic reports released over the past two weeks have added to the sense of uncertainty. Key surveys of the US service and manufacturing sectors from the Institute for Supply Management have shown that US companies are cutting back on hiring. The weekly jobless claims figures also indicated a slowing momentum. However, Friday’s monthly jobs report showed robust hiring, while inflation in May hit its highest level since late 1981.

Jan Hatzius, chief U.S. economist at Goldman Sachs, said there was “no doubt a labor market slowdown is underway”, adding that “job vacancies and quits are down , unemployment insurance claims are rising, the ISM manufacturing and services employment indexes have fallen to contraction levels, and many publicly traded companies have announced hiring freezes or slowdowns.”

Still, Hatzius said “fears of a looming US recession have eased somewhat” after figures showed the US economy added 372,000 jobs in June, well beating expectations.

The June jobs report also bolstered expectations that the Fed would raise rates by 0.75 percentage points at the end of July, bringing the central bank’s benchmark interest rate to a range of 2, 25 to 2.5%, compared to 0 to 0.25% at the start of 2022. .

Rate hikes have already pushed up borrowing costs in the United States, triggered strong selling in the corporate bond market, sparked the worst first-half selloff in Wall Street stocks since 1970 and helped make climb the dollar against its peers.

The combination drove financial conditions to their tightest level since the early days of the coronavirus crisis in 2020, according to an index compiled by Goldman. Tighter financial conditions generally spill over to the broader economy, weighing on output.

Even after the jobs report, a running economic forecast from the Atlanta Fed points to output contracting at an annualized rate of 1.2% in the second quarter of this year, following an annualized decline of 1.6% in the first trimester.

Andrew Hollenhorst, chief U.S. economist at Citigroup, noted that while the strong June jobs report “runs strongly against the view that the U.S. economy is in recession or will be imminently so” , the Fed’s emphasis on “slowing the economy to control inflation significantly increases the risk of a recession in 2023”. He added that “the very tight labor market could make it all the more difficult to ‘achieving a soft landing’.

The US government bond market is also showing warning signs. Two-year Treasury yields are trading about 0.04 percentage points higher than those on 10-year notes. The so-called inversion of the yield curve, in which the yields of short-term securities are higher than those of their long-term counterparts, is generally considered a gloomy sign for the economic outlook.

A recession in the United States has followed every inversion of the yield curve within six months to two years over the past five decades. The first yield curve inversion this year in March would put the U.S. on course for a recession by early 2024 at the latest, a prediction also reflected in other parts of the market.

Goldman Sachs FCI line chart showing US financial conditions tightening

“Right now there is a lot of uncertainty. Investors have very different probabilities of whether the recession will occur in the next 12 or 24 months,” said John Madziyire, head of US Treasuries at Vanguard. “But what has definitely happened is there’s been a deterioration in consumer confidence and business confidence.”

This more pessimistic outlook is also reflected in Fed rate hike expectations. Futures market trading suggests that investors expect the Fed to raise its key interest rate to a peak of around 3.5% by February 2023, but then start cutting rates to less than 3% by November of the same year.

A report this week on US inflation will help shed more light on the expected trajectory of Fed rate hikes. Wall Street economists expect the annual rate of consumer price growth to have hit 8.8% in June, from 8.6% in May, according to a FactSet survey.

“With last week’s jobs report showing continued strong payroll gains in a record tight labor market, barring a significant inflation disappointment this week, the Fed should be on track. to increase by another [0.75 percentage points] at its next meeting,” Deutsche Bank economists said.

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