Recession risk roils markets, but it's not alarming yet

The disappointing U.S. employment data has shaken the confidence that there will be a soft landing in the world's biggest economy. Global equity markets have tumbled and bets for interest rate reductions are surging.

Investors abandoning popular carry trades in yen have played a major role in the recent selloff. This has complicated the message that asset prices are sending about the economy.

Anyone can guess the likelihood of a U.S. recession. Goldman Sachs increased its odds of an American recession to 25%. JPMorgan believes that a recession could start before the end of the year.

Five closely watched market indicators reveal global recession risk:

DATA PUZZLE

In July, the U.S. unemployment rates jumped to a record high of 4,3% amid a slowdown in hiring.

The "Sahm Rule" was triggered, which historically has indicated that a recession begins when the rolling three-month average unemployment rate is half a point higher than the lowest point in the previous 12 months.

Many economists believe that the response to the data is overblown, as the numbers could be skewed due to Hurricane Beryl and immigration. The fact that the jobless claims figures on Thursday were better than expected also confirmed this view and sent stocks soaring.

"Payrolls continue to grow." "If you start to see payrolls go negative, I would be much more worried that a real recession is beginning," said Dario perkins, managing director global macro, at consultancy TS Lombard.

On an annualised rate, the U.S. economy grew by 2.8% in its second quarter. This is double the growth rate of the first quarter and comparable to the average before the pandemic. The services sector also indicates that growth will continue.

Business activity indicators outside the United States point to a faltering eurozone growth while China's economy remains fragile.

Citi's Surprise Index shows that global economic data has been delivering negative surprises at a rate nearing the highest since mid-2022.

CORPORATE ROUTE

The MSCI global stock index has fallen more than 6% since July's record-highs. Meanwhile, the U.S. S&P 500 is down over 4% in August.

Analysts believe that stocks are not yet signaling a recession, despite the fact they are up 7% this year.

Goldman Sachs estimates every additional 10% decline in U.S. equity prices would reduce growth by less than half a percent over the following year.

Analysts say that credit conditions may be more important than you think.

The report notes that, although corporate bonds have a higher risk premium than government bonds in Europe and America, the increase is still a correction from historically low levels.

According to BofA, the recession expectations implied by the difference between U.S. Treasury and investment grade bonds are half what they were in 2022-2023.

CUT AWAY

The U.S. employment data and the Federal Reserve's dovish tone have prompted traders to price in a rate cut of around 100 basis point by the end of this year.

This is down from the 130 bps predicted on July 29, but it's double what was expected. The markets also assume that there is a greater than 50% chance of an imposing 50 bps cut in September.

The Fed has also cut the amount of money that major banks expect to receive this year.

Steve Ryder, portfolio manger at Aviva Investors said that the Fed is likely to reduce rates three times in this year. However, given the uncertainty surrounding the economic data, it's understandable why markets are pricing the likelihood that they will have to lower them further.

Other traders expect three rate cuts from the European Central Bank this year. They had seen a less-than-full chance of a third cut at mid-July.

4/ YIELD CURRVE

The rate cut bets sent short-dated U.S. Treasury rates crashing and on Monday, the part of the yield-curve that tracks the difference between the 10-year and 2-year Treasury returns turned positive for first time since July 20, 22.

The yield curve will tend to return to normal when the recession is near.

A majority of the strategists polled in early this year do not see it as an accurate recession indicator.

Since then, the curve has inverted again and stood at minus five basis points on Friday.

5/ DR COPER

The metal, also known as "Dr Copper", is a well-known boom-bust indicator. Its recent fall to a 4-1/2 month low this week has put it on the list of recession watchers.

Copper prices on the London Metal Exchange for three months have fallen by around 20% since a record high reached in May. This is due to pessimism regarding global economic prospects.

Oil prices are at multi-month lows. Their fall has been restricted by fears that Middle East tensions may squeeze oil supplies from the region's largest oil producer.

(source: Reuters)