Stocks in Trouble if PMI Data Hints Fed Rate Cuts Are Too Late

Officials at the Fed have reiterated that bringing inflation back down to 2% will demand a slowdown 

• Fear of recession was at the heart of market turmoil in July and early August.

• Incoming PMI data may signal global growth will slow for a third month.

• Stocks may fall if Fed rate cuts seem to come too late to avoid a deep downturn.

Recession worries gripped financial markets in the second half of July and the first week of August. Much ink has been spilled blaming Japan and the now almost mythical-sounding “unwind of the carry trade,” but this is misleading. Yen-funded carry traders are typically unwound when risk appetite fizzles. It is a symptom, not a cause.

The real culprit is the Federal Reserve, and the real fear comes from the implications of what it seems to be saying. Since mid-2021, the U.S. central bank has firmly asserted a single-minded focus on battling inflation. Fed Chair Jerome Powell changed the tune in July, signaling that too-high unemployment is now a risk on par with sticky prices.

Put simply, this means a rapid rate hike cycle and the waning influence of fiscal largesse from the fight against COVID-19 have combined to put the brakes on the economy. That much was always in the cards: For nearly three years, Fed officials have tirelessly reiterated that bringing inflation back down to 2% will demand a slowdown.

Markets are saying the Fed is late on rate cuts

That this would be a benign affair—a gradual “letting the air out” of an economy bloated by the pandemic’s many aftershocks, the proverbial “soft landing”—has underpinned risk-taking by investors for almost a year. In this scenario, the Fed would only cut rates as a form of maintenance to keep credit costs steady as inflation expectations ease.

The central bank might still pull off this trick, but traders have grown suspicious. As Fed officials bemoaned the slow pace of disinflation in the first half of the year, the markets seemingly reckoned that their reticence to cut has already put them behind the curve. Seeing rates “higher for longer” in 2024 triggered repricing for sharp catch-up cuts in 2025.

Against this backdrop, last month’s pivot in Fed guidance was understandably interpreted to mean even the inflation-fearing U.S. central bank has perceived something worrying about growth trends, developing a sense of urgency about reducing interest rates. Recession fears rapidly swelled with every soft data point that followed.

In large part, this is because the U.S. economy has been a pillar of resilience amid an otherwise troubled backdrop for the other major engines of global demand. Eurozone economic activity growth has regressed to near-standstill after a shallow rebound from an almost-recessionary slowdown late last year. China has been moribund for over a year.

Stocks at risk if PMI data shows third month of global slowdown

That makes the incoming set of August purchasing managers’ index (PMI) data an important input, especially while markets await the next key update from the Fed when Powell speaks at the Jackson Hole Symposium this week. This will help traders get a sense of global growth trends, calibrating how urgent the need for stimulus appears.

July marked the second consecutive month of slowdown for growth in the global manufacturing and service sectors. Analytics from Citigroup warn that worldwide economic data outcomes have increasingly disappointed relative to baseline forecasts since mid-April, suggesting August may mark another step in the wrong direction.

This might turn up the volume on calls for Fed support as worries about a global downturn spread anew. Minutes from July’s meeting of the rate-setting Federal Open Market Committee (FOMC) suggest officials are inclined to oblige in September. However, stock markets may swoon if the PMIs hint that this might be too little and too late.

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

For live daily programming, market news and commentary, visit tastylive or the YouTube channels tastylive (for options traders), and tastyliveTrending for stocks, futures, forex & macro. 

Trade with a better broker, open a tastytrade account today. tastylive, Inc. and tastytrade, Inc. are separate but affiliated companies.