Stocks tumble, bonds rally over recession fears

A weaker-than-expected jobs report Friday kicked off fears of an impending recession, sending equities on a downward spiral, while bonds rallied. But economists say the economy remains strong, and while the jobs report missed projections, more than 100,000 jobs were added … not a shabby gain.

“U.S. economic growth data have been surprising to the downside since the end of April, but the July payrolls report released on Friday seems to be the proverbial straw that broke investors’ back,” said Jason Draho, head of Asset Allocation Americas at UBS Global Wealth Management. “Growth concerns flipped to recession fears, with some investors arguing that the Fed is waiting too long to cut rates.”

Recession fears sent stocks tumbling, with the Dow Jones Industrial Average down more than 1,200 points in early morning trading, recovering somewhat through the morning, although still off about 800 points. Other equity markets also fell big.

“The equity market reaction is no surprise,” said Steven L. Skancke, chief economic advisor at Keel Point.

If equity markets were “looking for a good excuse for a correction, the July employment data released last week is a pretty good one,” he said.

A stock market correction will continue, Skancke said, until “there is some indication of the economy and labor markets being OK.”

“Decelerating or slowing economic growth has sparked a classic flight-to-quality trade with short-term Treasuries being the prime beneficiary,” said Gary Pzegeo, head of fixed-income at CIBC Private Wealth U.S.

“What we are seeing is an unwinding of trades dependent on the higher-for-longer Federal Reserve theme,” he said.

“While the markets are likely to remain volatile in the near term and there could be more downside, similar to last fall when the S&P 500 fell 10% because of overheating concerns and the risk of more restrictive Fed policy, we expect concerns about growth and a Fed behind the curve will prove to be unfounded,” Draho said. “This could happen as soon as next month, if August payrolls rebound, implying that the July data was weather-distorted and not a signal of accelerating weakness.”

It can be a mistake to put too much stock in one data point — with Hurricane Beryl potentially contributing to the weakness of the July jobs report — but the report was “undeniably disappointing and will heighten concern that the Fed has kept rates too high for too long,” noted UBS’ chief investment office.

The employment report and stock market reaction led some observers to believe the Fed will cut rates by at least 50 basis points at its September meeting — or even before.

“Barring a stronger jobs report for August,” UBS thinks the Fed will cut rates 50 basis points at the September FOMC meeting.

“If the crater in markets continues up to the Fed’s September meeting, it’s likely the Fed’s rescue will start with a 50 or even 75 basis point move down,” said Jeff Klingelhofer, co-head of investments at Thornburg Investment Management.

“A recession seemed plausible — if not likely—before last week, and today we run the same risk. However, it was not imminent then and nor is it now,” he said.

However, UBS’ “base case remains that the U.S. economy will avoid a recession with growth remaining close to the 2% trend rate.”

“With rates at a 23-year high, the Fed has plenty of flexibility to support the economy and markets,” UBS said.

Still, Klingelhofer noted, “We are two days into a significant pull back, so let’s see where this actually heads.” He believes the Fed will rely on data, although “the market doesn’t like that and would prefer a more proactive Central Bank.”

Before the next Fed meeting, lots of data “will either confirm or question if this is recession, and if so, how deep it is,” he said. “If the data points significantly more toward the likelihood of recession, at the September meeting the Fed should be concerned with inflation missing because it’s below 2% and unemployment is moving up. The Fed will believe their cutting cycle will cushion the fall.”

“The poor July jobs report has led to market fears of impending recession and the need for an aggressive Federal Reserve response,” said James Knightley, chief international economist at ING. “Yet the latest ISM services report suggests the situation looks OK with the economy growing, adding jobs and with inflation above target.” 

Therefore, he does not expect an intermeeting Fed rate cut unless “systemic risk emerges.”

Based on the available data, Chris Low, chief economist at FHN Financial, believes “the Fed will not only stand firm and wait for the September meeting, we expect only a quarter-point cut.” “In this way, the Fed can project calm.”

In the meantime, Low said the Fed “can use forward guidance to encourage the markets to ease for them.”

“Either way, with the data and market pricing allowing for aggressive action, we believe the Fed won’t want to be slow in reacting to evolving economic conditions,” Draho said. “In other words, expect the Fed put to be exercised sooner rather than later.”

Federal Reserve Bank of Chicago President Austan Goolsbee, speaking on CNBC Monday morning, downplayed the employment report, suggesting a growth number over 100,000 jobs is weaker than expected but not a sign of recession, and said the Fed will be forward-looking and not rely on a single report,

“If we blow through normal, then we’re in a different situation and we would, in my opinion, we would need to react more robustly,” he said.