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Bloomberg macro strategist Simon White recently pointed out that US soft data is under pressure to a degree that has previously prompted the Federal Reserve to cut interest rates. If the easing of monetary policy is of sufficient magnitude and timing to prevent hard data from deteriorating and avoiding recession risk, the stock market could benefit.
Former President Trump consistently advocated for lower interest rates, but Fed Chairman Jerome Powell initially resisted. However, the Fed now appears to have valid reasons to take action, as soft data (survey and market data) indicates significant downward pressure.
While this might sound positive for stock markets, it is important to note that by the time the Fed cuts interest rates, the 'bad things' have often already happened, and the stock market is often in a downtrend. What makes the current situation unusual is that stock markets are rising and setting new highs while the Fed is considering cutting interest rates.
Both hard and soft data are crucial for tracking the evolution of the economy, but investors often focus more on the Fed's reaction to this data and its impact on assets.
Recessions often arise from the interaction between hard and soft data. Most of the time, these data evolve independently, but they can become intertwined at certain stages, creating a destructive negative feedback loop. Soft data starts to weaken first, and if this persists for too long, it can impact wealth through falling stock prices and suppressed investment, eventually causing the problem to migrate to hard data. Deteriorating hard data then, in turn, affects soft data, creating a vicious cycle that often ends in recession.
The Fed can try to intervene before the negative feedback loop forms. Soft data deterioration is often driven by sentiment, and policy easing can reverse this trend. However, if the Fed waits until cracks appear in hard data before taking action, it is almost certainly too late.
Therefore, if you want to anticipate Fed policy, you should focus on soft data rather than hard data. Current soft data is signaling warning signs. The chart below shows an analysis of a substantial quantity of hard and soft data. If a certain threshold is exceeded, it is defined as 'under pressure.' The results indicate that more than half of the soft data inputs are now under pressure, while hard data remains calm.
While the probability of a US economic recession in the near future is low, which is consistent with calm hard data, recessions often happen suddenly. There are at least two potential vulnerable sectors to watch:
For stock markets, the challenge lies in determining whether the potential slowdown indicated by soft data will eventually lead to a recession, and this largely depends on the timing and magnitude of easing by the Fed. The market is currently fully betting on a 'no recession' scenario. If a recession occurs, stock markets are likely to fall significantly from their current levels.
Disclaimer: This analysis is for informational purposes only and does not constitute financial advice. Investors should consult a qualified financial advisor before making any investment decisions.
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