Schwab Market Perspective: On the Line

Will the economy roll into a formal recession, or is a recovery underway? It's a close call.

We've believed all year that the economy has been undergoing a series of "rolling recessions" affecting various industries and sectors. The question is whether it eventually would roll into a formal recession. To date, it's still not clear. Despite the Federal Reserve's efforts to cool economic growth and control inflation, job growth has remained relatively strong—although job expansion historically is common at the beginning of recessions, as we'll discuss below.

Meanwhile, longer-term Treasury yields have risen sharply in recent weeks. While this traditionally is a sign that markets expect stronger economic growth in the future, we think there are other factors currently at work in the bond market: namely, increased bond supply and the potential for lower demand from Japanese buyers.

Finally, the global economy seems to be transitioning out of "stagflation" (low growth and high inflation), to just stagnation as the pace of economic growth and inflation is slow enough to end the rate hiking cycle in most major economies.

U.S. stocks and economy: Strengths and weaknesses

Economic data have looked relatively resilient lately. U.S. gross domestic product (GDP) growth reaccelerated in the second quarter to a 2.4% annualized pace, led by business investment and still-positive consumer spending (though the latter's strength eased from the first quarter). Meanwhile, the U.S. economy added 187,000 jobs in July, per the Bureau of Labor Statistics. While that is a strong gain relative to history, it was softer than the consensus expectation for 200,000 new jobs; also, the prior two months' job gains were revised lower by 49,000 payrolls.

Labor data can often look confusing at economic inflection points. One of the widely held myths around the labor market and recessions is that data don't look poor when a recession begins. That isn't the case, however, when looking at payroll gains at the start of historical downturns. As shown in the table below, out of the 11 recessions going back to the 1950s, nine of them began as the economy was still adding jobs.

Job growth is typical at the start of recessions