With stock markets crashing worldwide, are fears of a recession loading in the US pre-mature?

With US unemployment rates jumping from 4.1% to 4.3% in July 2024, the highest ever since October 2021, global markets fear an impending recession and a slowdown hitting the world's largest economy. Amidst a weakening labor market, even as interest rates remain consistent at a 23-year peak range of 5.25-5.5%, the number of unemployed people in the US inched up to 7.9 million in July.

Between January and June this year, the US economy added an average of 2,22,000 new jobs every month, which were significantly lower than the monthly average of 2,51,000 in 2023, and 3,77,000 in 2022. However, in July, the economy only managed to generate 1,14,000 new jobs.

Even Goldman Sachs economists have upped the probability of recession hitting the US by 2025 to 25%, from its previous estimate of 15%. And while they maintain that there still remain "several reasons to not fear a slump", it is hard to overlook the fact that July's employment figures have already breached the Sahm rule, which is considered a tipping point for foreseeing economic slowdowns. But is that indication enough, or are we reading too much into short-term market developments? Lets find out.

First, what is this Sahm rule?
Named after formed Fed economist Claudia Sahm, the rule says that a recession is almost certain, and more likely already underway, if the unemployment rate (based on a three-month moving average) inches up by 0.5% from its lowest point in the past year. It has been failsafe so far, proving right for every US recession since 1970.

But even as Sahm herself, and other economists believes that a recession is not imminent this time around, despite weak employment figures, the ongoing shockwaves in the global markets are hard to ignore. Japan's Nikkei 225 plunged 4,451 points today, and closed the day around 12.4% lower, registering one of the worst losses it has seen since 1987.

Closer home, Sensex fell sharply from the 80,000 mark it had previously breached by about 2,500 points to trade at around 78,400.21. Nifty also dipped around 2.5%, and was trading at about 24,098 points.

Vishnu Kant Upadhyay, AVP, Research and Advisory at Master Capital Services Ltd notes, the significant domestic equities sell-off has been primarily driven by weak global sentiments following disappointing U.S. economic data, particularly non-farm payrolls, manufacturing PMI, and jobless claims, which have raised concerns about a potential economic slowdown in the world’s largest economy. Additionally, the yen carry trade has further dampened global sentiment.

"However, given the prevailing bullish trend, it is unlikely that prices will remain low for an extended period. A recovery from these lower levels is a probable scenario", he continued.

Even Anup Kurup, CIO at InCred Global Asset Management sees this as short-term, largely because of the "positioning in the derivative markets with many players selling volatility across many asset classes. A big move up in VIX on Friday after the disappointment in the jobs report would have likely triggered margin calls on the short volume strategies, which were mushrooming off late", he explained.

So, what exactly is a recession?
This is when a country experiences a temporary decline in its overall economic activity, which has a cascading effect on lowering its GDP, income, sales and employment numbers. Generally, if the a country's GDP continues to fall for two successive quarters, it is said to have entered recession. When there is a recession, individuals and businesses tend to spend less, which further hinders wealth creation, industrial activity and trade, perpetuating the cycle.

However, in the first three months of 2024, US household wealth skyrocketed to a record $160 trillion, while household net worth touched $5.1 trillion, largely driven by the significant exposure of Americans to the stock markets, and the subsequent gains.

Notably, last recession (2008-09) was marked by ballooning household debt, which grew just 2.19% in the last quarter. So, while a recession might not be immediately on the cards, the upcoming months of September and December, where the Fed is likely to announce significant rate cuts, will be tracked intently. A rate cut would increase money circulation in the economy, thereby boosting spending and countering recession.

Transfer Pricing and International Economics subject matter expert Akash Kalra notes that this crash indicates a shift from rapid growth to a slower growth trajectory, rather than an immediate recession. Despite recent weak economic indicators such as higher unemployment claims and soft data in construction, durable goods orders, home sales, and manufacturing, the overall assessment is that the U.S. economy is transitioning to a slower growth rate, which is more vulnerable but not necessarily indicative of a recession.

"It is important to note that consumer spending has been growing at a moderate rate. In addition, capital spending remains strong due to robust corporate balance sheets and interest in AI technology. The housing market is subdued but stable, and government spending continues to rise. Trade positions are unfavorable but not deteriorating.
The Federal Reserve has signaled a potential rate cut in September due to softer economic data and diminishing inflation. Accordingly, the U.S. GDP growth is expected to slow down for the rest of 2024 before picking up again in 2025", he continues.