[Global Focus] US Economy: Recession or Soft Landing?

Employment Shock and Yen Carry Unwinding... Market Reacts to Indicators
Signs of Recession Everywhere... Opinions Divided
"On the Edge Between Hard and Soft Landing... Overreaction"

As concerns over a U.S. economic recession intensify, opinions on the outlook remain divided. While voices warning that the U.S. economy is heading toward a recession are growing louder, others argue that such worries are excessive. Despite the New York stock market, which experienced a rollercoaster ride last week, ultimately closing in a bull market and taking a breather, investors remain uneasy.

Amid recession fears, the New York stock market ended last week slightly lower but closed with gains across the board on the first trading day of this week, the 12th (local time). On the New York Stock Exchange (NYSE), the Dow Jones Industrial Average rose by %, the S&P 500 increased by %, and the Nasdaq Composite Index climbed by %, closing the session higher. The New York market, which plunged sharply on the so-called ‘Black Monday’ on the 5th, rebounded on the 6th, dipped slightly on the 7th, rallied again on the 8th, and showed a firm upward trend on the 9th.

Market Reacts Volatilely to Indicators... Market Still Uneasy

The main causes of the global stock market crash on the 5th, including in the U.S., were an employment shock and the unwinding of the yen carry trade. When the U.S. Department of Labor released the July employment report showing the unemployment rate soaring to 4.3%, recession fears rapidly spread in the market. This was due to the activation of the ‘Sahm’s rule,’ which has accurately predicted 10 out of 11 recessions in the U.S. since 1950, except for one in 1959. Sahm’s rule is an economic indicator that judges the economy to be in recession if the three-month average unemployment rate is at least 0.5 percentage points higher than the lowest rate recorded in the previous 12 months. However, Claudia Sahm, the chief economist at New Century Advisors who developed the rule, expressed caution in a foreign media interview on the 7th, shortly after the rule was triggered, saying she strongly senses recession risk but does not believe the economy has yet entered a recession phase. Amid widespread recession concerns and criticism of the Federal Reserve’s (Fed) missteps from leading scholars, the large-scale unwinding of the yen carry trade triggered by the Bank of Japan’s (BOJ) interest rate hike also exacerbated market turmoil.

Since then, the New York stock market has shown heightened volatility with sharp ups and downs every other day. On the 8th, investor sentiment improved immediately after weekly new unemployment claims decreased, easing concerns about a cooling labor market. However, the market atmosphere remains fragile.

It is expected that the market could fluctuate again depending on key indicators such as the Producer Price Index (PPI), Consumer Price Index (CPI), and retail sales, which will be released consecutively starting from the 13th. These indicators will provide important clues not only about signs of recession but also about the Fed’s monetary policy direction. Investors are also closely watching remarks from Fed Chair Jerome Powell at the annual Jackson Hole symposium scheduled for the 22nd to 24th, as his previous statements at this event have significantly impacted the market.

Not Yet? Growing Recession Signals Everywhere

When aggregating the consensus among experts inside and outside Wall Street, the general view is that the U.S. economy is not yet at risk of entering a recession. However, analyses indicate that recession signals are appearing in various areas.

Besides the cooling signals confirmed in employment data, a slowdown in consumption trends is evident in major corporate earnings. Representative examples include second-quarter results released by McDonald’s, Procter & Gamble, Walt Disney’s theme park business, Hilton Hotels, and Airbnb. These companies collectively expressed concerns about weakening demand during their earnings conferences.

Credit card debt has also reached an all-time high. According to the New York Federal Reserve’s household credit report, U.S. credit card debt totaled a record $1.14 trillion in the second quarter. The delinquency rate was 9.1%, the highest since the first quarter of 2011. While not as severe as during the 2008 financial crisis, this indicates that Americans’ spending capacity has diminished and household burdens have increased.

Additionally, political and geopolitical risks are scattered. Analysts warn that if former President Donald Trump, the Republican presidential candidate, wins the U.S. election in November, inflation could worsen immediately due to high tariff policies. The possibility of a direct conflict between Israel and Iran, which could drive up Middle Eastern energy prices, is another source of concern.

On the 7th, JP Morgan raised the probability of a U.S. recession this year from 25% to 35%. It also estimates a 45% chance of a recession in the second half of 2025. Earlier, Goldman Sachs increased its recession forecast from 15% to 25%.

According to financial data provider EPFR, investors withdrew $2.5 billion from junk bond funds between the 1st and 7th, the largest outflow since early 2020 at the start of the COVID-19 pandemic. Recession fears have shaken the market, causing massive capital outflows.

[Image source=Reuters Yonhap News]

"Urgent Action Needed Before Recession" vs. "Economic Conditions Are Sound"?Diverging Opinions

As market caution rapidly rises, experts’ opinions are divided. Nobel laureate economist Paul Krugman, a professor at the City University of New York, recently wrote in a New York Times (NYT) column that while the U.S. is not currently in a recession, it is on the brink of one. He compared the U.S. economy to a ‘pre-diabetic stage,’ emphasizing the urgent need for swift measures such as interest rate cuts, along with weight loss and dietary improvements.

Jamie Dimon, chairman of JP Morgan Chase, known as the ‘Emperor of Wall Street,’ estimated the probability of a soft landing at 35-40%, viewing the likelihood of a recession as higher. However, he stated that the economy is not currently in a recession. Brian Moynihan, CEO of Bank of America (BoA), ruled out a recession this year but expressed concern that if the Fed does not cut rates immediately, consumer sentiment will be severely hit.

On the other hand, some argue that such concerns are excessive and that the economy is still on a path toward a soft landing. David Solomon, CEO of Goldman Sachs, told Bloomberg News, "There will be no recession." Regarding the July employment report, the trigger for recent recession fears, he said it was "not a terrible report, just weaker than people expected."

Senior Fed officials have been making statements to soothe market sentiment. Jeffrey Schmid, president of the Federal Reserve Bank of Kansas City, said, "Overall, the labor market still appears healthy," adding, "While the July employment report caused many to question resilience, it is important that many other indicators show sustained strength." Thomas Barkin, president of the Richmond Fed, emphasized, "There is time to assess whether the economy is sound, stable, and moving smoothly toward a cautious normalization of interest rates."

The Problem Is Market Sentiment... "Confidence in Soft Landing Disappearing"

The issue is not whether a recession will occur but market sentiment. Investors have come to recognize the possibility that the previously soaring U.S. economy could fall into recession. Until recently, investors worried that strong U.S. economic performance might make rate cuts within the year difficult, but now they criticize the Fed for ‘missing the boat’ by not cutting rates in July.

Since last week, the market has been overly sensitive, reacting dramatically to every single indicator, largely due to this sentiment. The Wall Street Journal (WSJ) diagnosed, "The perception of being on the edge between a hard landing and a soft landing means investors are more likely to overreact to indicators. This leads to a shift from buying to selling sentiment, reduced remaining leverage, and makes it even harder for stocks to rise." Andrew Hollenhorst, an economist at Citibank, pointed out, "Once you start worrying about a recession, you usually end up in one."