2024-08-06 07:59:42
The markets are experiencing historic days. Investors have turned on the panic button about the possible entry of the United States economy into recession, which has led to heavy losses in stock markets worldwide.
With US unemployment climbing to 4.2%, there is a word that has taken over the American scene: recession. The idea of a strong and imminent economic contraction has taken hold, and the latest data has activated one of its big arguments.
In the United States, Wall Street started the week with losses of up to 6% in the Nasdaq Composite – a decline that moderated to 2.5% as better-than-expected data on the development of the services sector reassured the most pessimistic analysts.
The ISM index for the services sector, which rose to 51.4 in July from 48.8 the previous month, somewhat calmed investors’ worst fears.
ING strategists comment that “the situation looks favourable, with a growing economy, job creation and inflation above target”.
Last Friday the danger signal
The trigger for the falls in the stock markets, however, was the historic collapse of the Japanese stock market: the Nikkei sank 12.4% in its worst day since 1987. In Europe, the Euro Stoxx 50 fell 1.4%.
The beginning of this storm, however, was triggered last Friday with the release of weak employment data in the United States. The country added 114,000 jobs in July, below the 175,000 the market had expected, and the unemployment rate rose by two-tenths to 4.3%. Two figures that caused a scotch shower for investors who thought the world’s top economy could weather high interest rates without slipping into recession. Now the same investors fear that the Fed’s decision to keep interest rates unchanged until September – as its chairman, Jerome Powell, suggested at the July meeting – will worsen the economic slowdown, so much so that there are those who consider intervention necessary .
Although doubts about tech companies have already begun to erode the foundations of the world’s major indexes, the latest US employment data has caused that uncertainty to turn into chaos.
The Sam Rule
However, this situation was predicted by the American economist Claudia Sam, warning that the world’s largest economy is very close to recession, based on the “Sam rule”, named after her.
That rule says the country enters a recession when the three-month average unemployment rate rises 0.5 percentage points or more from its lowest point in the past year.
That threshold was breached when recent US government data revealed that the unemployment rate had climbed to 4.3%, the highest since October 2021. In July, the Sam rule reached 0.53 points, as the Federal Reserve Bank of St Louis.
But why does such a specific rule serve to predict recession? The reason is the logic it contains. If the economy is in a period where there will be successive layoffs, this spiral has a clear effect on the economy and can hardly escape the logic of recession. People lose their jobs or fear losing them, and as a result consumer spending falls, which makes companies earn less. This situation drives companies into layoffs, a loop that ends up meaning the economy enters a period of contraction.
The rule was confirmed 8 times
The “Sam rule” has been confirmed in the last 8 recessions, that is, in all those that have occurred in the USA since 1960. The only time it was not observed, in 1992, was in the months after the recession in which the country was in.
Speaking on Bloomberg Television’s Bloomberg Surveillance program, Sam, now chief economist at New Century Advisors, commented on the unexpected increase in the unemployment rate in the July jobs report, noting that this trend is historically consistent with the early stages of a recession. .
No immediate measures
Amid turmoil in financial markets and growing panic, Sam recommended no immediate action by the US central bank, stressing the importance of maintaining calm. He praised the Federal Reserve’s slow and deliberate approach, noting that quick, emotional reactions would be harmful. But he also said the Fed may need to adjust based on economic changes and the impact on markets
With the Fed’s benchmark interest rate currently between 5.25% and 5.5%, the US economist believes policymakers have considerable flexibility to act if needed. Regarding the rule, Jerome Powell himself spoke about it at the press conference last Wednesday, after the meeting in which the Fed decided to keep interest rates unchanged: “It’s a statistical regularity, it’s not a rule that shows that something will happen by 100%
However, the disappointing results from major tech companies in the US and the Fed already being open to interest rate cuts from September have caused a real panic in a market that had to assimilate very quickly a total change of narrative. We have gone from a soft landing to the need for aggressive cuts to avoid a recession that looks increasingly preordained. So much urgency has been built that the Bloomberg consensus already gives a 60% chance of a rate cut at an emergency meeting.
The fear index
The so-called fear index, Vix, which measures what investors pay to protect against the risk of falls on Wall Street, has however traded at historically very low levels. The index has soared to 42 points, a level not seen since the 2020 pandemic.
Citi strategists acknowledge that in recent weeks “we have seen increased risks of a hard landing as our economists believed that the Sam rule could be triggered soon.
“In this case, it turns out we should have worried less about the election and more about the rising risks of a hard landing, which means we should have reduced equity risk even more,” Citi strategists warn.