The likelihood of a coming downturn is increasing according to financial markets, following the wild ride through the markets last week that temporarily sent tremors through Wall Street.
It’s still a remote possibility. But according to models from Goldman Sachs Group Inc. and JPMorgan Chase & Co., based on signals in the US bond market and, to a lesser extent, the performance of stocks that are extremely sensitive to the ups and downs of the business cycle, the market-implied odds of an economic downturn have materially increased.
According to Goldman, the combined equity and bond markets are now projecting a 41% chance of a US recession, up from 29% in April. This increase is primarily due to market bets on a faster rate-cutting pace from the Federal Reserve and the underperformance of stocks, which are extremely vulnerable to changes in the business cycle. A comparable JPMorgan model estimates that because of the significant repricing of US Treasuries, the odds have increased to 31% from 20% since the end of March.
According to JPMorgan strategist Nikolaos Panigirtzoglou, the bank’s model’s recession risk is a reflection of the extent of rate cuts that have been factored in since the jobs report last month revealed a slowdown in job creation. The likelihood of a recession, according to the stock market, is now one in five, up from zero when stocks were setting new records earlier in the year, he said.
“US credit and equity markets look disconnected from US rate markets,” he said. “If the next US household survey for August is similarly weak to the July one, reinforcing the recession thesis, equity and credit markets would need to weaken significantly to catch up with rate markets.”
The less-than-expected job-growth data released on August 2 stoked worries about a downturn by fueling the notion that the Fed has been holding off on loosening monetary policy for too long. Even if the figures indicated a decline in hiring, the monthly rate was still above 100,000, and some indicators of the state of the economy don’t point to an impending recession. For instance, small-business optimism in the US recently rose to a two-year high in July.
Furthermore, the consensus of analysts’ projections hasn’t changed significantly from its April level of roughly 70% in 2023 to 30% now.
The tech-heavy Nasdaq 100 is down more than 8% from its top, while the S&P 500 has still dropped more than 4% from its record high set in mid-July.
According to the Goldman and JPMorgan models, rate markets are factoring in the increased likelihood of a recession for stocks. According to Goldman’s calculations, the 12-month forward implied shift in the Fed’s benchmark rate implies a 92% risk of a recession in the upcoming year, while JPMorgan’s analysis of the movement in five-year Treasury yields indicates a 58% chance of an economic slowdown.
However, there are a lot of encouraging signs in the mortgage and credit markets, where risk levels aren’t raising any red flags.
The head of asset allocation research at Goldman Sachs, Christian Mueller-Glissmann, stated that the company’s experts perceive only a 25% chance of a downturn, “which is still relatively low,” despite the increased chances assigned by its market model.
