Today’s market sell-off and the risk of recession

“The risk of recession rises every day that the Federal Reserve stays put.” That’s how I summed up my key takeaways from this week’s Fed meeting, and given today’s market plunge, it’s clear that markets are concerned that the Fed has waited too long to begin cutting and is committing a policy error.

At the time of this writing, the S&P 500 Index looks headed for its worst session in two years. Today’s stock market sell-off was fueled by a significantly lower-than-expected US jobs report, which came on the heels of a higher-than-expected initial jobless claims number as well as worse-than-expected manufacturing data. However, we think markets are overly worried about recession. While we do believe that the Fed has increased recession risks by not cutting in July, we still believe the job market is in relatively good shape and employers appear reluctant to cut employees.

We have to remember that market corrections are not uncommon, and they don’t typically come out of nowhere. They’re almost always the result of policy uncertainty and/or surprising weakness in the economy. The question is whether something larger is happening. In our view, we do not see the typical signs of a recession.

Having said that, markets have had a strong rally this year, suggesting very positive news is priced in, and so it makes sense that we are experiencing a meaningful correction given recent developments: growing instability in the Middle East, some tech earnings disappointment, and increased uncertainty about the US presidential election.

As we have said before, we think it is well past time for the Fed to ease conditions. We think it’s virtually a certainty that the Fed will cut rates in September – and likely again in November and December. The Fed may feel the need to provide a firm commitment to cutting in September in upcoming speeches if market jitters continue.

Our base case is that it is not too late for the Fed to begin to cut. We believe if the Fed does start to ease in September, it will likely be able to avoid a recession, and that the US economy would likely experience a re-acceleration in growth in late 2024/early 2025.

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