Is the economy at risk of a recession?

Disappointing July labor market data pushed stocks lower in early August. The July jobs report raised concerns the Federal Reserve (Fed) may be moving too slowly to cut interest rates. The report showed a slowdown in new job creation and an upturn in the unemployment rate.¹ That, at least temporarily, altered investor sentiment and contributed to the market’s rapid selloff.

After reaching a new all-time high in mid-July, the S&P 500 declined more than 8% in value by August 5. The NASDAQ Composite Index declined 13% from its mid-July all-time high.² Other factors, including diverging global central bank interest rate policies, also had an impact on markets during the sudden downturn.

“These drawdowns happen, but not very often,” says Eric Freedman, chief investment officer for U.S. Bank Wealth Management. Regardless of the most recent market setback, Freedman says “we still think it’s a great time to be invested.”

Economy gains steam in 2^nd quarter

In 2024’s first half, the U.S. economy continued to demonstrate resilience. Based on a preliminary estimate of second quarter Gross Domestic Product (GDP) growth, the economy expanded at an annualized rate of 2.8% during the period. That compares to 1.4% growth in the first quarter, and 2023’s 2.5%. GDP annual growth rate.³

The key question raised by the July jobs report is whether recent labor market data is an indication of a major shift in the country’s economic fortunes. “We aren’t inclined to think that’s the case,” says Bill Merz, head of capital markets research at U.S. Bank Wealth Management. “We see factors like weather-related work stoppages that may have skewed workforce data lower.” He also notes amid the volatile market environment, that trading remained orderly and plenty of investors remained in the market.

Second quarter GDP growth reflected increases in consumer spending, private inventory investment and nonresidential fixed investment. Consumer spending has consistently been the biggest driver of the economic expansion since a brief but deep, COVID-19-related recession in 2020. In the second quarter, consumer spending added 1.6% to GDP growth, with increases in both goods and services activity.³

“Consumer spending is proving resilient, and was somewhat elevated in the second quarter,’” says Rob Haworth, senior investment strategy director at U.S. Bank Wealth Management. “This report provides signs of a much stronger economy, but we add a note of caution that data from one quarter does not yet represent a trend.”

Haworth says there are signs of the slowing pace of economic growth. “Purchasing manager’s sentiment in June was weaker, particularly for the manufacturing sector,”⁴ notes Haworth. “In addition, durable goods orders recently slowed,⁵ and unemployment is trending higher.”¹ Haworth says that this clouds the economic outlook despite the second quarter’s favorable GDP trend.

Staving off a recession

Over the course of the 21st century, the global economy has confronted unique challenges, such as the financial crisis of 2007-2009 and the onset of the COVID-19 pandemic in 2020. Yet through a nearly 25-year period, the U.S. economy has expanded in all but two years. In the wake of inflation's surge in 2022, the Fed responded by sharply raising the federal funds target interest rate it controls. While designed to slow economic growth as a way to tame inflation, many analysts feared the Fed's actions, which led to higher interest rates across the economy and markets, would create too many economic headwinds, potentially resulting in a recession. Yet the economy has managed to grow consistently throughout this period of unusually high interest rates.

The early August market downturn was a signal that investors feel the Fed needs to act soon to reverse its recent interest rate policy. Markets anticipate that the Fed will cut rates beginning at its mid-September 2024 meeting, perhaps by as much as 0.50%.⁶ “After its July meeting, the Fed in its statement put more emphasis on being sensitive to changes in the labor market, when before they were almost totally focused on inflation data,” says Merz. “If the Fed continues to see a modest deceleration in inflation, but balances that with concerns about a decelerating labor market, it gives them more room to cut rates faster than they initially planned.” Merz says investors may see, in the coming months, potentially meaningful Fed rate cuts designed to help keep the economy expanding.

Can the economy stay on track?

“Modest, steady economic activity continues to be the path we appear to be on at this point, and there don’t seem to be signs of serious recession risk,” says Haworth. “Nevertheless, a big question that may drive the markets and the timing of Fed rate cuts is whether consumers can continue spending at a sufficient pace to keep the economy growing.”

Economic obstacles could still emerge, even as the Fed contemplates initiating rate cuts. “What surveys are telling us is that price levels are challenging for some consumers, and on top of that, borrowing is expensive as well,” says Haworth. “While that may ultimately impact consumer spending levels, we’re not seeing it yet.”

Stubbornly high interest rates complicate matters for businesses as well, particularly as it relates to business capital investment. “If rates stay elevated and companies are forced to issue debt with more significant financing costs, that could dampen business activity and threaten current expectations for economic growth,” according to Haworth. Nevertheless, corporate capital expenditures remain solid to this point.

Implications for investors

“We still think this is a positive investment environment,” says Freedman. “This is a well-telegraphed, slowing economy. If we felt there was a structural economic shift underway, we’d come to a different conclusion.” Freedman says consumers remain in a solid position to play a pivotal role in keeping the economic expansion intact.

Haworth says the combination of ongoing economic growth and persistent inflation make stocks more attractive relative to bonds. Haworth adds if the economy manages to demonstrate ongoing strength in the coming months, that could work to benefit non-technology sectors of the market that are more dependent on favorable economic trends. For example, utility stocks, which struggled in 2023, represent one of the top performing sectors within the S&P 500 year-to-date in 2024.⁷

Consider reviewing your current portfolio with your wealth management professional to determine if it’s consistent with your long-term goals and positioned to meet the challenges of what continues to be a dynamic market and economic environment.

Note: Diversification and asset allocation do not guarantee returns or protect against losses. The Standard & Poor’s 500 Index (S&P 500) consists of 500 widely traded stocks that are considered to represent the performance of the U.S. stock market in general. The S&P 500 is an unmanaged index of stocks. It is not possible to invest directly in the index. Past performance is no guarantee of future results.