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A major tsunami hit global markets at the beginning of the week, driven by fears that the US, the world’s largest economy, is heading towards a recession. This followed Thursday night’s disclosure of official data regarding unemployment figures, which indicated that an unexpectedly high number of Americans were jobless. These figures heightened concerns about the US economy, which is already under strain due to reported troubles in the manufacturing sector.
At the start of the week, investors faced record declines in global markets, following weeks and months of impressive stock price gains in the US, Japan, and other major markets worldwide. This decline occurred despite recent statements and data indicating improved inflation levels, growing optimism about future interest rate cuts, and positive expectations for technology and artificial intelligence earnings.
Currently, markets are closely watching the Federal Reserve’s (Fed) next move, anticipating that it may need to implement a sharp cut in borrowing costs in September or even sooner to boost demand. This forecast is driven by a significant slowdown in wage growth in July and a notable rise in the unemployment rate, making a rate cut in September appear almost certain. Consequently, there is growing speculation that the Fed might begin a monetary easing cycle by reducing interest rates by 0.5%.
What does it mean for an economy to be in a recession?
A recession is a significant and prolonged slowdown in economic activity. Generally, two consecutive quarters of negative GDP growth signal that an economy is in a recession. Some experts also assess additional indicators, such as employment figures outside the agricultural sector, industrial production, and retail sales. According to data from the International Monetary Fund (IMF), between 1960 and 2007, there were 122 recessions that impacted 21 developed economies.
A recession in the US?
Economists at Goldman Sachs have raised the probability of a recession in the US next year to 25%, up from 15%. However, they highlighted several factors that may mitigate concerns despite the rise in unemployment. In a report, economists at the bank, led by Chief Economist at Goldman Sachs, Jan Hatzius, wrote: “We believe the risk of a recession is limited. The economy seems to be in good shape overall, with no major financial imbalances. Furthermore, the Federal Reserve has significant ability to lower interest rates and can do swiftly so if needed.”
The economists expect a cut of 25 basis point in interest rate at the meetings in September, November, and December. However, JPMorgan and Citigroup currently are predicting a cut of 50 basis point at the September meeting. Goldman Sachs’ economists based their projection on an anticipated rebound in job growth for August. They believe the Federal Open Market Committee will view a cut of 25 basis point as adequate to address any downward risks.
What happens during a recession?
During an economic recession, economic output, employment rates, and consumer spending decline overall. In response, the central bank typically reduces interest rates to stimulate the economy. Concurrently, the government budget deficit usually grows as tax revenues decrease, while expenditures on unemployment insurance and other social programs increase. During the Great Depression, US economic output fell by 33%, stock prices dropped by 80%, and unemployment reached 25%. During the recession of 1937-1938, real GDP in the U.S. declined by 10%, while unemployment surged to 20%.
Why are global financial markets concerned?
Concerns about a potential US recession and uncertainty regarding the Federal Reserve’s future monetary policy, combined with fears of escalating conflicts in the Middle East and political instability in various European countries, have all contributed to significant declines in global financial markets, which experienced sharp losses on Monday. In this context, a US recession often triggers negative reactions in global stock markets due to the interconnection of economies. Investors may withdraw from riskier assets, leading to increased market volatility and declines.
The United States is a key trading partner for many countries, and a US economic recession can reduce American demand for imports. This decrease in demand, in turn, negatively impacts economies that heavily rely on exporting goods to the US. In fact, global stocks are facing losses amid concerns that the Federal Reserve is too slow in providing support to the US economy. The Fed has been sluggish in cutting interest rates, which impacts borrowing costs. Furthermore, some technology and artificial intelligence stocks may have surged beyond what their earnings potential would justify, indicating that the US stock market might be entering a correction phase.