Goldman Sachs, JP Morgan: Market is pricing in a higher probability of economic recession

Financial markets indicate that the possibility of an impending economic recession is increasing. Last week's market storm once triggered panic on Wall Street.

Although an economic recession still seems distant, models from Goldman Sachs and Morgan Stanley show that the market is suggesting a significantly higher likelihood of an economic recession based on signals from the U.S. bond market and the performance of stocks highly sensitive to the business cycle.

Goldman Sachs data shows that the stock and bond markets currently believe there is a 41% chance of a U.S. economic recession, up from 29% in April. This recent surge in likelihood is due to market bets on the Federal Reserve taking more aggressive rate cuts and the lagging performance of stocks highly sensitive to the business cycle. A similar model from Morgan Stanley calculates that, due to significant repricing of U.S. Treasuries, this likelihood has jumped from 20% at the end of March to 31%.

Morgan Stanley strategist Nikolaos Panigirtzoglou stated that the recession risk in their model reflects the scale of rate cuts already priced in since the non-farm payroll report showed a slowdown in job growth last month. He mentioned that the stock market is indicating only a 20% chance of an economic recession, despite reflecting zero likelihood when the stock market rebounded to new highs earlier this year.

"The U.S. credit and equity markets seem to be disconnected from the U.S. rate market," he said. "If the U.S. household survey in August is as weak as in July, further strengthening the recession argument, stocks and credit markets need to significantly weaken to catch up with the rate market."

Goldman Sachs financial market model shows a 41% chance of an economic slowdown

The lower-than-expected job growth data released on August 2nd has raised concerns about an economic slowdown, as people worry that the Federal Reserve has waited too long to start easing. However, despite the weak job growth data, monthly additions of new positions remain above 100,000, and various indicators of economic health have not signaled an imminent recession. For example, small business optimism in the U.S. recently reached its highest level in over two years in July.

Furthermore, the probability of a recession predicted by economists has not significantly increased. Since nearing 70% in 2023, the consensus since April this year has remained at 30%.

The likelihood of a recession priced in all asset classes is increasing

Since hitting a historical high in mid-July, the S&P 500 index has fallen by over 4%, while the tech-heavy Nasdaq 100 index has dropped by over 8% since its peak. The likelihood of a recession being priced in the rate market is higher than in the models of Goldman Sachs and Morgan Stanley. According to the Goldman Sachs model, the expected changes in the Federal Reserve's benchmark interest rate over the next 12 months imply a 92% chance of an economic recession in the coming year, while based on Morgan Stanley's data, the movement in the five-year U.S. Treasury yield indicates a 58% chance of an economic slowdown However, there are still plenty of reassuring signals in the credit and mortgage markets, with not too many worrying signs of risk levels. Christian Mueller-Glissmann, Head of Asset Allocation Research at Goldman Sachs, stated that although their market model has raised the possibility of a recession, the company's economists believe the likelihood of an economic recession is only 25%, "which is still relatively low."