Recession Risks And Election Risks Weigh On Financial Markets
![Recession Risks And Election Risks Weigh On Financial Markets Recession Risks And Election Risks Weigh On Financial Markets](https://i0.wp.com/imageio.forbes.com/specials-images/imageserve/66b0304490b1b5d6e6efb6f4/0x0.jpg?format=jpg&height=900&width=1600&fit=bounds&w=780&resize=780,470&ssl=1)
Equity markets are under pressure from the specters of recession, higher taxes, and increased uncertainty about the outcome of the 2024 U.S. presidential election.
Equity markets fell sharply last week. Photo by Johannes EISELE / AFP. Photo by JOHANNES EISELE/AFP … [+]
Economic Data Reveal Recession Risks
There were two major negative economic data points last week: the ISM Manufacturing Index and the unemployment rate.
Following a July 31 Fed policy decision leaving interest rates unchanged, the U.S. ISM Manufacturing Index surprisingly fell sharply on August 1. The ISM Manufacturing Index is a leading indicator of economic activity and growth. Its unexpected sharp decline and worsening contraction in July are potential signs of further economic slowdown or even recession.
In addition to weakening in the ISM, the August 2 jobs report showed that the July unemployment rate rose to 4.3%, while the number of nonfarm payrolls fell short of Consensus expectations, with a monthly increase of only 114,000 net new nonfarm payrolls. While the shortfall in payrolls was disappointing, many market analysts are far more concerned with the rise in the unemployment rate to 4.3% in July 2024 from 3.5% in July 2023 as a sign of a potential coming recession per the Sahm Rule.
The Sahm Rule postulates that a rise in the three-month moving average of the unemployment rate by 0.5% above its low over the prior 12-month period is a harbinger of recession.
Signs of Solid Economic Data
Despite the weakness in the U.S. ISM and unemployment rate, many economic data show that the U.S. economy and labor market are on solid footing. For example, the Job Openings and Labor Turnover Survey (JOLTS) data reflected almost 8.2 million job openings in June 2024.
The U.S. labor force also hit a new all-time record high in July at 168.4 million. With a record high labor force and continuing weekly jobless claims below 1.9 million, continuing claims reflect that only around 1.1% of the U.S. labor force is collecting unemployment benefits, according to the U.S. Department of Labor.
Plus, despite a tepid rise in payrolls by only 114,000, U.S. total payrolls rose to a new record above 158.7 million in July. Finally, the GDP growth outlook remains positive since the Atlanta Fed’s GDPNow for Q3 2024 reflects U.S. growth at +2.5% as of August 1.
Recession signs and solid economic data are providing mixed signals about the U.S. economy. This is probably why Fed Chair Jerome Powell stressed the Fed’s data dependence and its focus on “the totality of the data” when making future policy decisions at his press conference on July 31.
Total U.S. payrolls rose to a new record 158.7 million in July 2024.
Elevated Political Uncertainty
The worst case for financial markets and the economy following a U.S. presidential election is if it is not immediately clear who the winner is. When this happened in 2000, it became a major contributing factor to the onset of recession in early 2001.
Now that the U.S. presidential election looks likely to be close, financial markets have come under pressure as the risk of U.S. political uncertainty has risen.
Data from PredictIt.org, an online prediction market operating “under permission from the CFTC” as “ an experimental project operated for academic purposes,” shows how people are betting on who will become president, among other things. In mid-July, the percent probability of Donald Trump being elected president this November rose to an intraday high of 70%.
Things have changed significantly in recent weeks, and now it appears the election will be very close, increasing outcome uncertainty.
In less than three weeks, the odds of a Trump victory have fallen from an intraday high of 70% on July 15 to an intraday low of 49% on August 4. Meanwhile, the odds of Kamala Harris being elected president traded up to an intraday high of 54% on August 4.
The potential for a close U.S. presidential election is worrisome for financial market participants because of the contentious 2020 presidential election and the subsequent events of January 6, 2021. Any presidential election outcome short of decisive threatens to cast a long shadow of risk and uncertainty on financial markets until the result of the 2024 U.S. election is clearly declared.
Risks of Higher Tax Rates
With the increased potential of a Democratic presidential victory this fall, financial markets may also be pricing in the risks of higher corporate tax rates and higher capital gains tax rates.
The Biden 2025 tax plan called for a significant increase in the corporate tax rate, raising it to 28% from 21%. The plan also called for raising income tax rates and other taxes, including raising “the top marginal rate on long-term capital gains and qualified dividends to 44.6 percent.”
Financial market participants likely expect a future Harris administration to push for directionally similar policies. As such, the risk of higher taxes has risen as Harris’ chance of winning has improved.
Recent equity market movements lower are about pricing in risks — and the risks of higher corporate tax rates and higher capital gains tax rates fundamentally detract from equity valuation. These risks have piled on top of broader economic and election uncertainty risks.
Looking Ahead
Economic releases in the week ahead are light, making next week’s growth and inflation reports critical for policy expectations and financial markets. With few economic releases this week, equity markets, the dollar, and bond yields could remain under pressure until next week’s July CPI inflation report.
The July CPI inflation report is likely to show easing year-on-year inflationary pressures, and the July PPI is likely to show relatively benign year-on-year inflation rates. With easing year-on-year inflationary pressures, the dollar and bond yields could come under additional pressure. As long as growth data doesn’t weaken significantly, equity markets might improve with easing inflationary pressures and higher prospects of Fed rate cuts.
Modest monthly declines in next week’s July retail sales and industrial production reports would not significantly change growth prospects or the outlook for a relatively soft landing. However, significant declines would likely be seen as additional worrisome signs of a potential hard landing for the U.S. economy.
On the downside, if prospects of a hard economic landing increase, equities could continue falling next week even if inflationary pressures ease — especially if U.S. election outcome uncertainty remains high.
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