- Stocks look like they could benefit from the best of both worlds: falling inflation and a still-strong economy.
- Investors were briefly spooked this month after jobs data came in soft, fueling recession fears.
- However, recent economic data suggests that a soft landing is on the horizon.
The stock market’s best-case scenario got a second lease on life this week.
That may come as a surprise to investors who panicked earlier this month after the labor market proved weaker than expected in July, with unemployment rising to its highest level since the pandemic. .
Investors have since clawed back those losses and then some, with a big rally on Thursday spurred by the latest economic data that breathed new life into Wall Street’s dream of cooling inflation and a growing economy. stable and growing.
“The extremes of sentiment have reflected excessive worries about the recession,” Tim Hayes, chief global investment strategist at Ned Davis Research, said in a note. “For the US and globally, pessimism has given way not only to a sense that recession fears have been overblown, but also to expectations of a more dovish Fed, which is almost certain to follow other central banks in tapering of rates next month”.
Wall Street strategists are taking solace in four recent data points that suggest the economy is headed for a soft landing.
Inflation is definitely falling
Consumer prices came close to the Fed’s 2% target last month, rising 2.9% on an annual basis in July, according to the Bureau of Labor Statistics. That’s lower than the 3% annual growth economists expected and below the 3% annual growth recorded in June.
“The bottom line is that the trajectory of slowing inflation has slowed materially, but is likely to remain within a comfortable range for the Fed to initiate a series of rate cuts,” said Charlie Ripley, a senior investment strategist at Allianz Investment Management. notice this week.
Investors have been waiting for rate cuts throughout the year. When the Fed starts easing policy, it could potentially trigger a 1995-like rally in stocks, Wells Fargo’s head of global investment strategy said this week.
“The CPI report is a green light for the Fed to cut interest rates in their next decision,” Bill Adams, chief economist at Comercia Bank, said this week.
Comercia expects the Fed to release a 25-basis point rate cut at the next four policy meetings, with 150 basis points of cuts to come over the next 12 months.
Investors are seeing an even steeper pace of policy easing, with markets pricing in a 41% chance the Fed could cut rates by 100 basis points by the end of this year, according to the CME FedWatch tool.
Jobless claims are at their lowest level in five weeks
Jobless claims came in lower than economists expected, with new applications for jobless benefits falling from the previous week to 227,000 last week, according to the Labor Department.
Jobless claims rose to a one-year high in early August, but the surge in jobless claims could be due to severe weather events such as Hurricane Beryl, some strategists said.
“The good growth in activity indicators in July suggests that the increase in unemployment during the month was not due to a slowing economy. More likely, it reflects the impact of Hurricane Beryl on the Texas labor market and perhaps an increase in the entry of workforce due to Immigration and college graduates are entering the job market,” said Comercia’s Adams.
“Today’s retail sales data and jobless claims provide further evidence that recession risk remains low in the US even as the economy slows from unsustainable levels of strong growth,” added Ronald Temple, chief strategist at market at Lazard.
Consumer spending marked an unexpected increase
Retail sales saw the biggest jump in more than a year in July, with sales rising 1% compared with estimates of 0.3%.
Those results are consistent with a “softer economic outlook,” Bank of America analysts said in a note this week, adding that they expected two 25-basis-point interest rate cuts to come from the Fed this year. year.
“Retailers caught a midsummer tailwind from consumer spending in July, providing another strong piece of data that shows the economy remains on an expansionary path,” added Jim Baird, CIO of Plante Moran Financial Advisors. .
“Consumers have become more cautious with their spending as they continue to face higher prices and borrowing costs, but recent retail sales data show a continued willingness to spend,” Lydia Boussour said in a statement. , a senior economist at EY, adding that the firm did not foresee a “consumer contraction” on the horizon.
Small businesses are feeling more secure
Small business confidence rose to the highest level recorded since February 2022, just before the Fed issued its first rate hike, according to the latest survey by the National Federation of Independent Business.
The number of small business owners who expected to invest in inventory over the coming months rose four basis points in July, the first positive reading since October 2022.
The percentage of owners expecting higher real sales volume also rose four basis points to the highest level so far this year, the survey added.
“The NFIB’s SMB Optimism Index hitting its highest point in almost 2 1/2 years, along with new data this week showing a slowdown in inflation, suggest that the recent spike in fears of recession was unjustified,” John Caplan, CEO of finance. firm Payoneer, told Business Insider.
Despite renewed hope for a softening scenario, some forecasters warn that there is still a good chance of recession on the horizon, depending on whether the labor market and economic activity continue to slow. New York Fed economists see a 56% chance the economy will enter a recession by July next year, according to the latest forecasts from the central bank.