Signs of an economic cooldown? European retail sales dip while U.S. job gains slow

On the latest edition of Market Week in Review, Portfolio Manager Olga Bezrokov and ESG and Active Ownership Analyst Elizabeth Jackson discussed the recent cooling in economic data in Europe and the U.S. They also chatted about the market’s surprising reaction to the numbers and provided an update on the probabilities of a U.S. recession.

Consumer spending on the decline in Europe

Jackson and Bezrokov kicked off the conversation with a look at the latest economic data from the eurozone. Bezrokov stated that the region is seeing evidence of a continued deceleration in economic activity, with the newest retail sales and PMI (purchasing managers’ index) numbers indicating a broad slowdown in consumer spending. In addition, European businesses are also experiencing a slowdown in demand, she said, noting that new business intakes recently fell at the fastest pace since 2012, excluding the COVID-19 pandemic.

"This deceleration of the consumer is not too surprising, as European household savings have declined and are dampening spending," Bezrokov remarked. She added that one of the key risks is that the spending slowdown is occurring at the same time as businesses confront borrowing costs that have doubled – or in some cases, nearly tripled – over the past year.

Turning to the U.S., Bezrokov said that all eyes are on the nation’s labour market, which appears to be slowing overall. In October, the U.S. economy added 150,000 nonfarm payrolls, she said, which was lower than expected and significantly less than the 297,000 job gains seen during September. The October employment report also showed a deceleration in wage growth, Bezrokov added. However, layoffs haven’t picked up yet, she noted, with weekly initial jobless claims largely holding steady over the past few weeks.

"Overall, though, there was a small upward tick in U.S. continuing jobless claims, which may be a signal that it’s becoming a bit more challenging to find employment. This, together with a slight increase in the unemployment rate in October, does suggest the U.S. jobs market is softening – albeit from historically tight levels," Bezrokov stated. She noted that a somewhat similar story appears to be playing out in Canada, with the pace of job creation also slowing and inventories ticking up.

U.S. equities rebound from October lows

Next, Jackson asked Bezrokov how markets have been reacting to the weakening economic data. Bezrokov said investors have generally shrugged off the numbers, instead focusing on some of the more dovish comments from U.S. Federal Reserve (Fed) officials as well as the central bank’s recent decision to leave interest rates unchanged. "In the eyes of the market, it’s all about rates right now," she remarked.

With investors increasingly optimistic that the Fed could be done raising rates this cycle, there’s been a fairly dramatic reversal in U.S. equity and fixed income markets over the past few weeks, Bezrokov said. Overall, major U.S. benchmarks are up anywhere from the mid-to-high single digits since 26 October, while the U.S. Treasury yield has fallen by about 40 basis points (bps) since hitting 5% in mid-October, she noted. "This has been a big reprieve from the downward pressure on assets we’d seen since late July, and has also been beneficial for the traditional 60% equities/40% fixed income portfolio," Bezrokov stated.

That said, she stressed there are a few watchpoints for investors pertaining to the upswing in markets. For instance, a sharp fall in yields and a big rise in equity markets would spell looser financial conditions – the exact opposite of what the Fed has been trying to accomplish over the past year and a half. If this were to occur, Fed officials might have to strike a more hawkish tone in order to continue bringing inflation back down to its target. "This could mean that markets may become stuck, or range-bound, for a little while, leading to the potential for more volatility over the coming months," Bezrokov explained.

What are the chances of a U.S. recession in the next year?

Jackson and Bezrokov wrapped up the segment by discussing the U.S. economic outlook and the path for rates moving forward. Bezrokov noted that monetary policy works with a lag, and that the recent softening in the jobs market and the deceleration in inflation rates both reflect the so-calledlong and variable lags of alterations in monetary policy.

Going forward, she said that further signs of a cooldown in the U.S. labour market will be a key watchpoint for investors. Bezrokov explained that in the past, modest increases in the nation’s unemployment rate have tended to be decent predictors of future, much larger increases in unemployment – and subsequent recessions.

"The increases that we’ve seen so far in the U.S. unemployment rate do not reach the level of these past modest increases. However, at Russell Investments, we do see the probabilities of a recession in the next 12 months at about 50-50,” Bezrokov stated. As for thefuture path of U.S. monetary policy, Bezrokov said that with indications from many Fed officials that inflation expectations are currently well anchored, no changes are anticipated for now.

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