As Global Recession Worries Grow, Markets Look to U.S. Consumers for a Lifeline

If consumers don't rally, stocks may keep falling as the dollar gains

• Stocks swoon, dollar gains despite "goldilocks" U.S. inflation data.
• U.K. GDP data to show the economy stalled in the second quarter.
• Health of U.S. consumers is critical and the University of Michigan sentiment survey is in focus.

July’s U.S. consumer price index (CPI) data was seemingly as benign as the markets might have hoped for. Veering too far away from baseline forecast one way or the other seemed fraught with danger ahead of the release.

As it happened, headline inflation came in at 3.2% year-on-year, a touch softer than the 3.3% expected. That seems about as supportive for risk-taking as traders could want: a touch soft to keep Federal Reserve hawks at bay, but not so weak as to sound the alarm about economic growth.

The response from stock prices was decidedly darker. The bellwether S&P 500 stock index briefly popped higher, then violently turned in the opposite direction. In tandem, the U.S. dollar probed weekly lows only to reverse sharply upward a mere 90 minutes later, erasing the data-driven selloff and then some.

Winter is coming?

It seems telling that the bulls were swiftly routed in the wake of economic data that ought to have put a pep in their step. They might yet manage to win back some ground before the closing bell is sounded on Wall Street. Nevertheless, the weakness on display so far suggests the pendulum swing against them is gathering steam.

The markets’ response to last week’s U.S. jobs report was similarly dour: a data set that might have been celebrated as just ‘goldilocks’ enough—much like the CPI print—concluded in stocks slumping and the greenback on the rise. Whatever investors are afraid of, they seem to be increasingly defensive.

Worries about a broad-based business cycle downshift are a likely culprit. The Fed estimates it can take 12 to 18 months for the impact of a single rate rise to be fully absorbed into the economy. So, pressure from the bulk of last year’s outsized 50- and 75-basis-point rate hikes ought to be appearing right about now.

Global economy on the ropes

Meanwhile, the global backdrop is sobering. The Eurozone is flirting with recession, if not already in one. Germany’s economy—the bloc’s largest—shrank 0.6% in the second quarter. Purchasing manager index (PMI) data suggests regional manufacturing- and service-sector activity contracted in July, implying that the weakness is spreading.

China—the world’s second-largest economy—is still struggling to recover after reopening from “zero-COVID” restrictions in December. Trade data published earlier this week was even weaker than the markets’ timid forecasts (as expected), while inflation fell below zero for the first time since the pandemic lows of late 2020 to early 2021.

Up next, U.K. gross domestic product (GDP) data is expected to show the economy has stalled in the three months to June, a worse result than even the pitiful 0.1% expansions recorded in the prior two quarters. It may be weaker still, considering data from Citigroup showing U.K. economic outcomes have increasingly softened relative to forecasts.

U.S. consumers to the rescue?

With Europe and China in dire straits, the United States amounts to the last line of defense still standing against a global slump. That puts the burden squarely on U.S. consumers. So, a closely watched report on their disposition from the University of Michigan might find a still broader audience when it is released on Friday.

Economists’ forecasts suggest that while the assessment of current conditions will hold up, the broader sentiment index will be pulled lower as forward-looking expectations deteriorate. If markets walk away from the release with a sense that consumer appetite is waning, the “risk off” drive will probably accelerate.

Ilya Spivak, tastylive head of global macro, has 15 years of experience in trading strategy, and he specializes in identifying thematic moves in currencies, commodities, interest rates and equities. He hosts Macro Money and co-hosts Overtime, Monday-Thursday. @Ilyaspivak

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