US recession fears are overblown, experts say

Despite concerns that the Federal Reserve may have delayed cutting interest rates too long, economists are urging caution against overreacting to fears of a looming recession. After the Fed decided to hold interest rates steady last week, Chairman Jerome Powell indicated that a rate cut in September is possible, with some officials having supported a cut as early as July. However, a strong majority opted to maintain the current rate level.

A recent report from the U.S. Labor Department showed that the jobs market cooled more than expected in July, with employers adding 114,000 jobs—significantly below the anticipated 185,000—and the unemployment rate rising to 4.3%.

While the report raised some concerns, San Francisco Fed President Mary Daly emphasized that the U.S. economy is decelerating but not deteriorating. "This is what we would expect: slowing but not falling off a cliff," she said at a forum in Hawaii.

The market reaction was swift and severe, with global markets plunging as fears grew that the Fed was behind the curve on rate cuts. Wall Street experienced its worst day since 2022, and volatility spread to Europe, Asia, and the Middle East. U.S. stocks hit session lows on Wednesday.

"I’m kind of surprised that the markets have responded so strongly to it," said John Leahy, a macroeconomics professor at the University of Michigan and former New York Fed visiting scholar. Satyam Panday, chief U.S. economist at S&P Global, echoed this sentiment, suggesting that too much focus was placed on the unemployment rate.

"We are of the view that it is more normalization than anything else," Panday said, noting that the rise in unemployment was due to an increase in labor force participation, which inched up from 62.6% in June to 62.7% in July.

Strategists also expressed surprise at the market's reaction. Clark Capital Management’s Chief Investment Officer, K Sean Clark, wrote to clients that the market's fears of a Fed policy mistake are likely an overreaction. Peter Andersen, founder of Andersen Capital Management, attributed the strong negative reaction to the influence of artificial intelligence companies in the market. Shares of Nvidia, Tesla, Alphabet, Amazon, and Meta all experienced significant declines, underscoring what Andersen described as the "tender underbelly of this market."

Despite market jitters, Andersen argued against rate cuts this year, suggesting that the Fed's current rates still need time to impact the economy fully. He noted that while some sectors are struggling, overall consumer sentiment and stock market performance remain strong.

For over a year, the Federal Reserve has maintained higher interest rates to achieve a "soft landing"—slowing the economy without triggering a recession. Since beginning its tightening cycle in 2022, the Fed has raised rates from near-zero to a range of 5.25%-5.50% to combat rising inflation. As of now, the Fed’s preferred inflation metric has dropped to 2.5%, nearing its 2% target.

Signs of a cooling labor market have emerged, with job gains slowing and the unemployment rate ticking up. Last week, the Federal Open Market Committee acknowledged that the risks of inflation and employment are becoming more balanced. "They now weigh both inflation and the employment mandate basically equally," Panday said.

S&P Global's baseline scenario predicts a 50-basis point rate cut this year, starting with a quarter-point cut in September. However, the likelihood of an emergency rate cut before September remains low.

After Powell hinted at the possibility of rate cuts, U.S. mortgage rates fell to a 15-month low of 6.55%, according to the Mortgage Bankers Association.

While geopolitical risks, the U.S. election, and potential financial market disruptions could affect the Fed's course, Panday does not see a recession as the most likely outcome. Determining whether the U.S. is entering a recession remains challenging, given the lag in employment data. "It's not clear—we might be going into a recession. We might not be going into a recession," Leahy said.

Powell's recent remarks suggest the Fed is closer to cutting rates than at any time since it began raising them in March 2022. "The amazing thing is how the Fed has brought inflation down from decade-highs to something in the range of its target without there being significant slowdown of the economy," Leahy observed. "And the Fed has almost stuck the landing."

As the Fed navigates the delicate balance between curbing inflation and maintaining employment, economists remain cautiously optimistic that a soft landing is still within reach.