Macro update: growth scare vs. recession risks

The July employment report in the US showed softer-than-expected job gains and a further rise in unemployment that triggered the Sahm rule. Recession concerns rose sharply with markets quick to price in around 125bps of cuts by year-end, and high odds of an inter-meeting cut before the September FOMC.

We were already expecting a slowdown to below-trend growth in the US in H2, with downside risks. We now expect three 25bps rate cuts at the Sept, Nov, and Dec meetings. Increased labour market slack and progress on disinflation suggest monetary policy could be overly restrictive, and a quicker return to neutral is appropriate from a risk-management perspective. 

However, we don’t think current data warrant a 50bps rate cut from the Fed in September, or an inter-meeting cut beforehand, nor do we see recession as the base case. First, we expect a partial weather-related rebound in the August employment data. Second, hard data on spending and balance sheets suggest a labour market that is cooling in an orderly fashion. Survey data has been misleadingly soft for more than a year. Lastly, for an outsized/inter-meeting cut to happen, the FOMC would need to see more than one month of data to extract signals from the noise, or significant dislocation in the credit market. 

We view the Fed easing cycle as policy normalisation, not labour market rescue. However, the risk at full employment in an environment of low hiring and low firing is that unemployment rises nonlinearly, leading to a vicious cycle of job and income losses. If evidence of layoffs increases further or financial conditions tighten unexpectedly with credit stress, then 50bps and an easing cycle resembling past recessions would become more likely. 

We still expect the ECB and the BoE to cut rates twice more this year, to 3.25% and 4.5%, respectively, by year-end, with risks tilted towards more easing. We also expect the SNB to cut rates to 1% in September, with risks tilted towards a larger cut as well as FX interventions to mitigate CHF strength.

In this note, we address key questions for the economic and monetary policy outlook. Are we headed to a recession? Did weather play any role in the employment data? What kind of easing cycle does the outlook warrant?