Stock market jitters and the case for a US soft landing

Markets react to US economic fears

First, let’s set the stage.¹ Stocks fell globally last week, but the drop was sharpest in the US with the S&P 500 Index down 4.2% and the NASDAQ Composite Index down 5.8%. The Dow Jones Industrial Average held up better, down just 2.9%. The 10-year US Treasury yield dropped to its lowest level in more than a year. The 2-year US Treasury yield fell about 25 basis points last week. Crude oil prices fell again, reaching their lowest level since December 2023.

So what happened last week to ignite those jitters?

• Manufacturing data disappointed. The US ISM Manufacturing Purchasing Managers’ Index (PMI) was 47.2 for August — this was up from 46.8 in July but still very much in contraction territory.² Of particular concern was the new orders sub-index, which clocked in at 44.6 – which was 2.8 percentage points below the July reading.² The S&P Global US Manufacturing PMI reading was 47.9 for August, down from 49.6 in July.³ This survey also saw a decline in new orders. S&P Global Market Intelligence Chief Business Economist Chris Williamson warned, “The combination of falling orders and rising inventory sends the gloomiest forward-indication of production trends seen for one and a half years, and one of the most worrying signals witnessed since the global financial crisis.”³
• Jobs data hits three-year low. The Job Openings and Labor Turnover Survey (JOLTS) for July showed a large decline in US job openings. The decline of 237,000 jobs brought job openings to the lowest level in 3½ years.⁴ And the August jobs report showed 142,000 non-farm payrolls created, which was below expectations.⁴ The two previous months saw downward revisions to new jobs as well.
• Economic activity in decline. In addition, last week’s Federal Reserve Beige Book revealed that the number of Fed Districts that reported flat or declining economic activity rose from five in the prior period to nine in the current period – and only three Districts saw economic activity grow (slightly).⁵

Markets could find more reasons to be nervous. For example, Dollar Tree lowered its annual forecast last week, reiterating that lower-income consumers are under pressure. And Chicago Fed President Austan Goolsbee shared that “If you’re going to have a soft landing, you can’t be behind the curve,” underscoring the fear that the Fed may already be behind the curve.⁶

In addition, the 2-year/10-year yield curve “disinverted” last week — returning to its normal shape in which shorter-term rates are lower than longer-term rates. Some might assume this is a positive development as inverted yield curves are considered to be a recession indicator. However, disinversions aren’t seen as a good sign — they’re a signal that markets are pricing in rates cuts due to negative economic data, and so they suggest we may be one step closer to the start of a recession. However, thus far it has been an unusual cycle with an extremely long period of yield curve inversion that has already defied historical norms, so I’m not putting too much stock into this one development.

Five reasons I expect a soft landing

In fact, I remain confident that our base case scenario – a relatively soft landing – will come to fruition. Following are five reasons I believe the US economy will experience a soft landing:

1. The services side of the economy is doing well. And services is a far bigger portion of the US economy than manufacturing. While manufacturing PMIs are relatively weak, services PMIs are strong. The S&P Global US Services PMI for August clocked in at 55.7, up from 55 in July.⁷ This was the strongest growth in the services sector since March 2022. And the ISM Services PMI in the US edged higher to 51.5 in August from 51.4 in July, which was above expectations.⁸ Importantly, new orders rose in both surveys.
2. The job market is cooling in a measured and appropriate way. Job openings fell significantly last month but from an elevated level; they are now at the high end of where they were pre-pandemic. In addition, the layoff rate remained low, which is very important to me; we even saw the job hires rate rise modestly. This paints a picture of a relatively healthy job market that is slowing in an orderly fashion.
3. I expect real wage growth to improve as disinflation continues. Inflation continues to move closer to the Federal Reserve’s target. That, coupled with lower but still solid wage growth, means that real wage growth (which is adjusted for inflation) is likely to increase meaningfully. This should help power the consumer – in particular taking pressure off lower income consumers – which should be positive for the economy.
4. I expect the Fed to cut significantly in the coming year. This is not going to be the Greenspan Fed of 1995 with just three rate cuts for the year, in my view. I expect the Fed to ease substantially in the next year, which should help power a re-acceleration of the US economy.
5. The presidential election season will be over soon. Political uncertainty has clearly dampened spending and hiring, and generally weighed down on sentiment. From last week’s Federal Reserve Beige Book: “Hiring has shifted to be primarily for replacement, rather than growth, and with uncertainty pertaining to the presidential election ahead, many firms have put hiring plans on hold.”⁹ And while it seems like election season will never end, Americans go to the polls in less than two months, so that uncertainty should be resolved. In a number of surveys, consumers and businesses have indicated they will resume spending plans once the presidential election has been decided. We can also look to the UK as a guide; the economy seems to have gotten a meaningful boost following its election in early July.

Finally, I don’t mean to be dismissive of areas of weakness in the US economy, as they are there. In fact, they are more pronounced but similar to those seen in Europe and Canada, where manufacturing has been weaker but services has been stronger. The difference is that the US has benefited from greater fiscal largesse from its government during the pandemic as well as the grand privilege of long-term fixed rate mortgages. However, I believe all these economies will re-accelerate in coming months as they benefit from continued easing; the Bank of Canada cut rates last week and I’m confident the European Central Bank will cut rates this week. Of course, that doesn’t mean we aren’t going to see more market jitters in the near term. I believe we should be prepared for volatility and not react to it with fear, but instead look for opportunities to add exposure to oversold asset classes.

Looking ahead

Eyes will be on the US Consumer Price Index (CPI) and the European Central Bank (ECB) meeting this week, although CPI is far less important now that markets are more concerned about growth rather than inflation. I expect the ECB meeting will likely result in another rate cut given recent economic data that has been weaker than expected.