How concerned should we be about these resurgent recession fears? Recall that the U.S. economy is is going through a period of adjustment, with activity continuing to decelerate and, so far this year, its performance has even been somewhat above initial expectations. and that, so far this year, its performance has even been somewhat above expectations at the beginning of the year.

What to expect from the Federal Reserve?

We are closer to the beginning of an easing period, after having gone through the most aggressive tightening cycle in the last 40 years, with the interest rate at the tightest level in history, and experiencing the second longest pause on record after 2006-2007. and also experiencing the second longest pause on record after the 2006-2007 period.

At its July meeting the FED left the rate unchanged in the 5.25%-5.50% range, as expected; however, However, it modified its speech to reflect the possibility of a cut in September. For the past two and a half years, inflation has been the main axis around which monetary policy has revolved, but now - with a greater conviction that inflation is moving in the right direction - FOMC members are beginning to move towards achieving their second mandate, which is full employment. In doing so, they are showing greater sensitivity to downside risks to the labor market.

Since the FOMC's last release of economic projections in June, core PCE inflation has fallen to 2.6%, below the year-end projection of 2.8%, and the unemployment rate has exceeded the year-end forecast of 4.0%, standing at 4.3% in June. The question that has arisen then is. will the Fed be too late to cut rates?

All of this has driven market euphoria about rate expectations in the coming months. rate expectations in the coming months, so that not only are rate cuts now expected for each of the three remaining meetings of the year, but it is also anticipated that the first two would be of 50 bp, while the third would be 25 bp, but it is also anticipated that the first two would have a magnitude of 50 bps, while the third would have a magnitude of 25 bps. Thus, now more than ever, the outgoing data will be decisive for the conduct of monetary policy.

How much has the labor market deteriorated?

So far, the adjustment in the labor market has been a natural response to an economy that is cooling after facing overheating conditions. Recent data proved disappointing for the market. The July non-farm payrolls report showed the creation of 114,000 new jobs, far below the 175,000 expected. In addition, some of the data from previous months was revised downward. The unemployment rate unexpectedly rose to 4.3%, above the projected 4.1%. Finally, wage growth was 3.6%, the lowest in more than three years.

Should we be concerned about these figures? Not necessarily, as the labor market is adjusting to a slower level of economic growth. Let us remember that, beyond the growth forecast for this year, which would be above 2.0%, most growth projections for the medium term indicate a stabilization of GDP, around a rate of 1.8% per year over the next decade.

In any case, over the last three months, the average increase in payrolls is 170 thousand, which while representing a significant decrease from the average of 600 thousand in 2021 and 380 thousand in 2022 (post-pandemic outlier years), would be more in line with the 180 thousand average monthly increase observed after the last period of economic expansion (2010 - 2019).

The unemployment rate remains historically low, considering that between 1948 and now, the average is 5.7%. Moreover, to date, the increase in unemployment is due more to an increase in the labor force than to a fall in employment, the increase in unemployment is due more to an increase in the labor force than to a drop in employment. Also, the number of job openings is greater than the number of unemployed (7.2 million).

What about other recession indicators?

Much is being made of the Sahm Rule, which states that the initial phase of a recession occurs - for the United States - when the three-month moving average of the unemployment rate is at least half a percentage point higher than the 12-month low. July's employment data would have triggered the rule; however, the same author would have pointed out that we are not in a recession now, even if the direction is that way.

On the other hand, the yield curve has been inverted for more than two years, meaning that short-term bond yields have been higher than long-term yields. But now, with the Fed hinting at an early onset of tapering and downside economic risks, the bond market has begun to reflect a more aggressive easing cycle.

The performance of the treasury 2-year treasury yields, which are more sensitive to monetary policy, fell below 4.0% for the first time since May 2023, while the treasury 10-year Treasury fell below 3.8% for the first time so far in 2024. Going forward, there would be room for further declines, depending on the path of cuts the Fed takes. The next thing that should happen is that short-term yields should fall faster than long-term yields, so the yield curve should normalize.

What about volatility?

During the first half of the year, the VIX index, which measures volatility, averaged around 14 points, 30% below its long-term average. remained, on average, around 14 points, i.e. 30% below its long-term average. However, that has changed since the start of the second half of 2024 and intensified last week, following the monetary policy decisions of three of the world's major central banks and important macro data from the United States.

Concerns that the Federal Reserve will be late with a rate cut, coupled with uncertainty over the U.S. presidential election, have driven volatility, which is particularly sensitive this time of year, have driven volatility, which is particularly sensitive at this time of year. Precisely, historical data show that the period between August and October is when stock markets record the highest volatility and the lowest returns.

Also, the statistics note that between 1941 and 2024, when the S&P 500 was up 10% or more in the first six months of the year, it was also up 7% on average in the second half. The percentage of times returns were positive in the second half of the year was nearly 80% versus 66% in any given period, but, in the case of setbacks in the second half, these tended to be deeper than in the first half, averaging 9%.

All these are cold figures that, undoubtedly, fall short of what was observed in the market on this first Monday of August. and, of course, no mention is made here of other reasons for the movements and flows of capital that led to the losses that day at all levels in the financial markets, but they do help to regain some perspective for looking ahead.

Milene Rodriguez
Strategy and Investment Analyst