Eve Maddock-Jones (pictured), acting editor at Investment Week
Back in May, when markets began to accept that fact that the Federal Reserve was on a different rates path to what they were expecting, investors were confronted with the fact that while the chances of zero rate cuts in 2024 were not high, the fact that it wasn’t zero anymore was significant.
Arguably, a similar phenomenon is happening now, as expectations of a US recession alter from very unlikely to not completely off the table after markets became complacent to the risk of one happening at all.
Investors diverge over US recession concerns amid global market sell-off
Less than a month ago, managers were bullish that although US monetary policy was too restrictive, the easing could reach the soft landing ‘goldilocks zone'.
Forecasts that the most likely outcome for the global economy over the next 12 months will be a "no landing" reached a six-month low of 18%, according to the BofA Global Fund Manager survey, while only 11% of investors saw a "hard landing".
But cut to last Friday's (2 July) weaker US jobs report, it had the market questioning the likelihood of a soft-landing, and debating if the US had already slipped into a recession.
The data spooked markets and, triggered by concerns over the health of the US economy, investors embarked on a global equity sell-off, all while blaming the US Federal Reserve for keeping interest rates too high.
Fed officials attempt to reassure markets that US is not headed for recession
This has coincided with an ‘unwinding of the carry trade', which relates to investors having borrowed cheap Japanese yen in this case to invest abroad, mainly in other higher-yielding currencies or fixed income products.
Several traders told Investment Week that this triggered the equity volatility, but this has become a bit of a ‘chicken and the egg' debate.
An unwinding of this type of carry trade tends to happen for a couple of reasons, one of which is volatility and this case began not on the back of the Bank of Japan's interest rate hike the week prior, but rather the broad equity sell-off.
Leaving some room for argument that the latter sparked the former versus the other way around.
But either way, both have fallen into a vicious cycle of exacerbating the other, and there is more unwinding set to come.
One unlikely but neat explanation for of this week's market antics came from Julian Howard, chief multi-asset investment strategist at GAM Investments, who contemplated "whether or not the summer silly season or juniors manning trading desks while bosses lie on the beach can explain the irrationality".
He added that investors should "brace for over-reading of all the key datapoints heading to the next Fed meeting in mid-September".
Japanese index suffers worst ever fall as traders rattled by
But back to the ‘R' word, and while investors continue to wring their hands about whether the US is already in severe economic decline, some are arguing that this call misses the mark.
Mark Dowding, BlueBay CIO, said "broadly speaking, US data are consistent with a softish landing and there is little evidence to back up a recessionary claim".
He continues to back a 25bps cut at the Fed's September meeting, which currently has a 45.5% likelihood, according to the CME FedWatch Tool.
A 50bp cut is priced at a 53.5% chance.
On Monday, the odds of this were at 15% while back in late July, 94%.
So frankly who knows what will happen, although one thing we can likely be surer of, is that the clamour for emergency rate cuts is not going to work.
Karen Ward, chief market strategist EMEA at JP Morgan Asset Management, pointed out in her monthly newsletter, that 18 months ago, most of the forecasting community, herself included, was expecting a US recession after the Fed had carried out some of the most aggressive rate hiking cycles in history and then slammed on the proverbial breaks.
When this happens, Ward said "a soft landing is incredibly rare, and more commonly the US economy shudders to an uncomfortably abrupt stop".
But instead, the "US economy showed extraordinary resilience" and while she could not completely shake off the worries that "the mischievous ‘long and variable' lags could still spell trouble ahead", and that a recession is not totally off the cards, if one did happen, it would be "short and shallow".
Ward, along with Karsten Junius a chief economist at J Safra Sarasin Sustainable Asset Management, Tiffany Wilding, managing director and economist at PIMCO, BofA analysts and members of the BlackRock Investment Institute do not believe that the US fell into a recession in July, or that it is in imminent risk of doing so just yet.
It is worth pointing out that coming into this year 44% of fund managers were expecting the global economy to fall into recession in the first or second quarter of 2024, up from 36% in September 2023.
So, these recessionary concerns should be nothing new, the US' economic strengths and/or weaknesses have not really changed that drastically, but rather, people have hoped it would be better so that the Fed will get around to giving the market what is wants, which is lower interest rates.
The falls in markets have been intense this week, with a lot of moving factors colliding at once, but maybe everyone needs to dust off their investment packs from a year or so back and remember that we were expecting worse than this before so please, let's relax.
This article was first published as part of the Friday Briefing series on the 9 August, which is available exclusively to Investment Week members each week. Sign up here to receive the Friday Briefing to your inbox each week.
