"Wall Street" Soothes the Market: Recession Concerns Overdone, Risk Assets May See a Rebound

Due to the significantly lower-than-expected July non-farm payrolls report, Wall Street's focus has shifted from rate cuts to the timing of the U.S. economy entering a recession. Nevertheless, some analysts still believe that, although the risk of an economic recession has increased, the market seems to have overreacted somewhat.

Torsten Sløk, Chief Economist at Apollo Global Management, stated in a media interview on Tuesday that the market has "digested too many rate cut expectations."

Following the release of the non-farm payrolls report on Friday, expectations for four rate cuts within the year surged, with some analysts even suggesting that the Fed should urgently cut rates before the September meeting. However, Sløk believes that given the drastic fluctuations in the market's bets on Fed rate cuts over the past few trading days, investors should maintain a "skeptical attitude" towards the market's pricing.

Sløk also pointed out that data shows consumers are still spending on air travel, dining out, and hotel stays, indicating that there are no signs of a reduction in consumer spending at present.

Overall, there is not much evidence to suggest that the economy is entering or heading towards a recession.

Resilience in the Labor Market Persists, Fed May Not Need to Cut Rates Urgently

In the July non-farm payrolls report, the most concerning part was the unemployment rate - rising to 4.3% and triggering the well-known recession indicator, the Sam Rule. The report also showed that the number of new jobs added in July hit the second-lowest record since 2020.

Brett Ryan, Senior U.S. Economist at Deutsche Bank, believes that while there hasn't been strong hiring in the labor market, the situation of layoffs has not worsened, implying that the economy may not be heading towards a recession.

The composition of the rise in the unemployment rate is different from what is typically seen in the early stages of an economic recession.

Ryan believes that the increase in the unemployment rate is largely due to an increase in labor supply - either from first-time entrants to the labor market or those returning to work - rather than an increase in the number of layoffs.

Investors should not overreact to a single data point. Therefore, while the risk of a recession has increased, the inclination for the Fed to start taking more aggressive rate cuts is there, but it has not reached that point yet.

Initial jobless claims for the week ending July 27 recently hit the highest level in nearly a year, but Ryan pointed out that if excluding Texas (where Hurricane Belel caused flooding and worker displacement), the four-week average of initial jobless claims is actually decreasing.

Michael Gapen, U.S. Economist at Bank of America, also holds a similar view. In a recent client report, he wrote that without significant layoffs, the rationale for large-scale emergency rate cuts is weaker than what the market is pricing, and the labor market may be stronger than what the market imaginesGapen wrote in a report to clients on Monday:

A rate cut in September is now a sure thing, but we believe the economy does not need a significant rate cut like during a recession.

Goldman Sachs CEO David Solomon previously stated that the U.S. stock market correction is healthy, there is no risk of recession in the U.S. economy, and the Federal Reserve is not expected to cut rates urgently.

Solomon expects the Fed to cut rates once or twice in the fall, and he also mentioned that as the market readjusts to new economic data and revises expectations for Fed policy, market volatility will continue for some time.

After a very strong rally in the market, we are going through an adjustment, which may be healthy. I think in the short term we will see more volatility. This is quite a significant adjustment.

"Risk Assets May Rebound"

In addition, some strategists see the significant pullback in U.S. stocks as a buying opportunity.

BlackRock Investment Institute led by Jean Boivin wrote in a report on Monday:

We believe that as concerns about economic recession ease and rapid unwinding of arbitrage trades stabilizes, risk assets can recover. Driven by artificial intelligence, we continue to overweight U.S. stocks and see the sell-off as a buying opportunity.

The team stated that concerns about economic recession in the market have been "exaggerated."

Principal Asset Management's Chief Global Strategist Seema Shah agreed with this view. Shah stated in a media interview that the market rebound on Tuesday "is a bit of a reality check, that economic concerns may not be as bad as expected."

Shah added that the key for investors in the current market situation is whether the macro environment has fundamentally changed. As of now, she believes the situation remains largely unchanged.

We expect the U.S. economy to slow down, but not enter a recession. The Fed will cut rates, but not significantly. Therefore, from this perspective, the macro environment has not really changed for us