The disappointing U.S. July non-farm report once shook the outside world's confidence in the soft landing of the world's largest economy, leading to a global stock market plunge and a surge in bets on interest rate cuts. Investors abandoning the popular yen carry trade played a significant role in the sell-off, complicating the mapping of asset prices to economic prospects.

Goldman Sachs and JPMorgan Chase have recently raised the probability of a recession to 25% to 35%, respectively. For investors, after experiencing a wave of panic selling, it is necessary to guard against the associated risks and spillover effects.

Labor Market Fog

Due to a significant slowdown in hiring, the U.S. unemployment rate in July soared to a three-year high near 4.3%, reaching the trigger point of the "Sahm rule," intensifying concerns about an economic recession. The rule states that when the three-month rolling average unemployment rate is half a percentage point higher than the low of the previous 12 months, an economic recession is underway.

Nevertheless, many economists believe that the reaction to these data is exaggerated, given that immigration and Hurricane Beryl may distort the figures. The latest unemployment benefit claims data released last Thursday also supports this view.

Advertisement

However, the normalization trend in the labor market is evident. Job vacancies have fallen by one-third after reaching a record high of 12 million two years ago. As a result, the unemployed need a longer time to find new jobs. Despite this, the U.S. job market remains robust according to most indicators.

At the same time, the increase in the unemployment rate is largely due to more people entering the labor market to look for work. Since January, about 1.2 million people have joined the labor market. If these people do not find jobs immediately, they will be classified as unemployed until they find work. People usually tend to enter the labor market when they think jobs are easy to find. San Francisco Fed President Daly said last week: "Companies are not laying off. Companies are just slowing down the pace of hiring."

Dario Perkins, Managing Director of Global Macro at consulting firm TS Lombard, said: "Wages are still growing. If you start to see wage growth turn negative, that would make me more worried that a real recession is beginning."

It should be noted that under the uncertainties of geopolitical tensions, monetary policy, and weak demand, the Citigroup Economic Surprise Index shows that global economic data is presenting the highest level of negative surprises since mid-2022.

Soft Landing and Yield CurveAffected by restrictive monetary policy, the manufacturing and real estate industries, which account for a quarter of the U.S. economy, are facing a severe test. In July, the manufacturing PMI across various regions in the United States remained below the boom-bust line. Meanwhile, high mortgage rates driven by high interest rates and high housing prices are simultaneously impacting private real estate transactions and the value of commercial properties.

At the most recent interest rate meeting, the Federal Reserve signaled a rate cut in September. Federal Reserve Chairman Powell hinted that if inflation continues to cool, the Fed might take action in September.

However, unusual fluctuations in economic data are sending out warnings. Some market observers are concerned whether the Fed has kept interest rates at a high level for too long, which could harm the opportunity to achieve a soft economic landing. On the other hand, easing monetary policy when the economy is relatively strong could reignite inflation, limiting the extent to which the Fed can ultimately cut rates. George Catrambone, head of fixed income and trading at asset management firm DWS, said: "There is reason to believe that a soft landing is still possible... but the risks are two-way."

Bets on rate cuts led to a plunge in U.S. Treasury yields at the beginning of this month, with the yield curve tracking the gap between 10-year and 2-year Treasury yields turning positive for the first time since July 2022. Although an inverted yield curve has historically been seen as a good predictor of an impending economic recession, as the recession approaches, the curve often returns to normal.

First Financial Journal reporters noted that the New York Fed's recession probability based on the yield curve has returned to 56%, continuing to be at a high level since the 1980s.

Analysts say that changes in credit conditions may prove to be more important. They pointed out that although the risk premium of corporate bonds relative to government bonds has widened in Europe and the United States, the change is not sufficient to indicate a high risk of recession. Bank of America believes that the gap between U.S. investment-grade bond and Treasury yields suggests a recession expectation of about half for the years 2022 to 2023.

Key commodities face pressure.

"Dr. Copper" fell to a four-and-a-half-month low near $8,700 last week, putting it on the recession watch list of many institutions.

As copper prices enter a bear market, they reflect pessimism about the global economic outlook. First Financial previously reported that multiple factors have caused a reversal in the trend of the "global economic barometer." First, copper inventories registered at the world's three major exchanges exceed 500,000 tons. Second, there is no sign of stabilization in global manufacturing. Third, the U.S. elections also pose challenges to many demand scenarios. Previously, the growing long-term demand from the new energy industry and electric vehicles has been a reason for investors to enter the market.

Oil prices are another barometer of global demand health, also hovering at a yearly low. OPEC on Monday revised down its global oil demand growth forecast for 2024 by 140,000 barrels per day, to 2.11 million barrels per day. This is the first time OPEC has revised down its forecast for oil demand growth since it announced the forecast for this year in July 2023. There is currently a significant divergence in forecasts for 2024 oil demand growth among major global institutions, and OPEC's forecast remains at the highest level in the industry. Weak global economic data has put pressure on oil prices, as the market worries that a slow economic recovery will suppress fuel consumption, which also introduces uncertainty to the planned production increases of OPEC oil-producing countries.A source close to the oil-producing countries' alliance OPEC+ said that the organization still has a month to decide whether to increase production starting from October and will study oil market data in the coming weeks.

Mazen Salhab, Chief Market Strategist for the Middle East and North Africa at the international financial institution BDSwiss, said: "Traders can continue to pay attention to the development of the U.S. economy and its impact on oil demand. With significant changes expected, the direction of U.S. monetary policy may still be a strong market driver."