US recession fears are overblown, experts say

Economists and strategists puzzled after weak jobs report sparks global market downturn

Stock market information displayed at the Nasdaq market site in New York. Bloomberg

Despite fears that the Federal Reserve has fallen behind the curve on cutting US interest rates, economists believe fears of a looming recession are an overreaction.

After deciding to hold rates steady last week, Fed chairman Jerome Powell signalled a rates cut in September is on the table and suggested some officials favoured one in July, but a strong majority wanted to keep rates at their current level.

A monthly employment report released by the Labour Department showed the jobs market had cooled more than expected in July.

Employers added 114,000 jobs compared with expectations of 185,000, while the unemployment rate ticked up to 4.3 per cent.

While the report appeared concerning, San Francisco Fed president Mary Daly said there is more confidence that the US economy is decelerating but not deteriorating.

“This is what we would expect: slowing but not falling off a cliff,” she said during a forum in Hawaii.

Market overreaction

Fearing the Fed had fallen behind the curve – as well as the potential for war between Israel and Iran – global markets hit the panic button.

On Monday, Wall Street had its worst day since 2022. Market volatility spread into Europe, Asia and the Middle East, while US stocks hit session lows on Wednesday.

“I'm kind of surprised that the markets have responded so strongly to it,” said John Leahy, a macroeconomics professor at the University of Michigan and former New York Fed visiting scholar.

Satyam Panday, chief US economist at S&P Global, agreed: “I was quite surprised by the reaction that came out."

Both said too much focus had been placed on the unemployment rate.

“We are of the view that it is more normalisation than anything else,” Mr Panday said.

And while Mr Leahy considered the report “certainly concerning” and a “mixed message”, he noted the increase in the unemployment rate was because more people had entered the labour force.

The labour force participation rate, which measures the percentage of people in the workforce or looking for work, slightly increased from 62.6 per cent in June to 62.7 per cent in July.

Strategists also appeared surprised by market moves.

“The market is pricing in a policy mistake by the Fed with new recession fears and is worried that the Fed is now behind the curve,” Clark Capital Management chief investment officer K Sean Clark wrote to clients.

"We believe that is probably an overreaction."

Peter Andersen, founder of Andersen Capital Management, said the strong negative reaction is because of the huge influence the artificial intelligence companies have in the market.

Nvidia and Tesla shares have fallen nearly 16 per cent since last Thursday. Shares in Alphabet, Amazon and Meta have dropped as well.

“It shows you the tender underbelly of this market right now,” Mr Andersen said.

He supports no rate cuts this year and believes the Fed's interest rates still need to work their way through the economy.

“I know there are pockets of the economy that doing very poorly but, in general, consumer sentiment is strong.

"The stock market is strong. Companies' earnings [have] high expectations, but so far they have been exceeding those expectations.”

Cooling labour market

For more than a year, the Federal Reserve has held interest rates at their current level in the hopes of achieving a soft landing, slowing the economy without pushing it into recession.

The Fed first embarked on its tightening cycle in 2022, raising interest rates from their near-zero level to their current range of 5.25-5.50 per cent in response to a global surge in inflation.

The US central bank's preferred inflation metric has fallen to 2.5 per cent, close to its 2 per cent target.

At the same time, there have been signs of a cooling labour market, most notably in a slowdown in job gains and a rise in the unemployment rate.

The Federal Open Market Committee acknowledged last week that these two risks are coming into better balance.

“They now weigh both inflation and the employment mandate basically equally, like the risks around it are being weighed equally," Mr Panday said.

"You know, previously, it was more on the inflation side.

“If you are going to wait equally, then yes, the labour market, things that are happening right now has to be taken into consideration and it's better to start cutting rates sooner than later.”

Mr Panday said S&P Global's baseline scenario is for rate cuts of 50 basis points this year, starting with a quarter-rate cut in September, before cutting by 125 basis points in 2025.

Already, investors have virtually locked in a September rate cut. The idea of a rate cut before the September meeting – which would mean an emergency rate cut – is unlikely to happen.

“An emergency rate cut seems to think that … if the Fed doesn't act the world's going to fall apart. It's not obvious that the world's going to fall apart,” Mr Leahy said.

With Mr Powell insinuating the likelihood of a rate cut, Mr Leahy said telegraphing such actions feeds into rates that directly affect consumers.

After the rate-cut signals, US mortgage rates fell to a 15-month low at 6.55 per cent, the Mortgage Bankers Association reported on Wednesday.

Soft landing still within sight

After a bumpy first quarter, a soft landing appears within sight.

“That is our base case, actually. We do think that's the most likely case,” Mr Panday said.

Risks such as geopolitical factors, the US election and potential disruptions in the financial market all have the potential to throw the Fed off course. But Mr Panday said a recession is not the most likely scenario.

Assessing whether the US is in the beginning of a recession is difficult to determine as well, given the lag in employment data.

“It's not clear – we might be going into recession. We might not be going into recession,” Mr Leahy said.

Mr Powell last week suggested the Fed was closer to cutting rates than at any time since first raising them in March 2022.

“The amazing thing is how the Fed has brought inflation down from decade-highs to something in the range of its target without there being significant slowdown of the economy,” Mr Leahy said.

“And the Fed has almost stuck the landing. Do I think that … [had] they lowered rates on last week, rather than in September, it would have a huge effect? Probably not.”