A recession on the horizon?

If we were to see…inflation moving down quickly, or more or less in line with expectations, growth remains let’s say reasonably strong and the labour market remains consistent with its current condition, then I would think that a rate cut could be on the table at the September meeting. If inflation were to prove sticky and we were to see higher readings from inflation, disappointing readings, we would weigh that along with the other things.

Financial markets have been rattled by the prospect of weaker growth. The key questions for investors are:

• Is a rate cut too little, too late to stave off a downturn?
• Has market psychology turned and bad news is now bad news?

What’s bothering markets?

The markets were also unsettled by unexpected weakness in the ISM Manufacturing PMI and continued a trend of disappointing ISM readings.
 

Too little, too late?

Is a rate cut a case of too little, too late?

 

The economy is softening, both at the high end and the low end. The CFO of luxury goods maker LVMH recently observed in an earnings call that there is a “severe demand issue in champagne”, explaining that “champagne is quite linked with celebration, happiness, et cetera. Maybe the current global situation, be it geopolitical or macroeconomic doesn’t lead people to cheer up and to open bottles of champagne.” By contrast, French fry supplier Lamb Weston said: “the operating environment has changed rapidly during fiscal 2024 as global restaurant traffic and frozen potato demand softened. In fact, the downward traffic trends accelerated during the back half of the year and into early fiscal 2025”.
 

Leading indicators of the jobs market are also signaling weakness. Both temporary employment and the quits to layoffs ratio have been trending down, which are indications of a cooling labour market.
 

She pointed out a key anomaly in the current circumstances. What’s really unusual is new job entrants to the labour force aren’t losing their jobs compared to last Sahm Rule recessionary triggers. Sahm attributed this to the effects of immigration: “Increased labour supply from immigrants pushing up unemployment and not a sign of weakening demand as is typical in a recession.”
 

Despite all the hand wringing over the Sahm Rule trigger, the prime age employment to population ratio and participation rates rose to multi-decade highs. These are the signs of a strong economy and not one that’s falling into recession.
 

A soft landing

Putting it all together, I believe the U.S. economy is undergoing a Goldilocks, not too hot and not too cold, economic soft landing. The monthly NFIB Optimism Index is a good indicator of the economy for two reasons. First, small businesses have little bargaining power and they are good barometers of the growth outlook. In addition, small business owners tend to be small-c conservative and lean Republican, which is an important indicator during an election year.
 

The trend in real GDP growth and real final sales are strong. Even though growth rates may decelerate, recessions don’t look like this.
 

With the flattening of the 2 vs. 10 year Treasury yield, that spread becomes neutral. Additionally, real money supply continues to get “less bad.” On the other hand, mortgage applications. The remaining indicators have slowly changed back to either neutral or positive.

Both the short leading indicators and the coincident indicators have generally been improving over the past few months, albeit with some noise. The decline in the price of gas has been, as usual, well received. The coincident indicators, driven by strong consumer spending and more time inflation, are very positive.

In addition, productivity gains are strong, which sets the stage for non-inflationary growth.
 

For equity investors, whether the economy is recessionary or pre-recessionary matters. Analysis from Goldman Sachs shows that the stock market has continued to rise in past rate cuts if the economy continues to grow, but fallen if the economy is in recession.