Before the economic downturns of 1990, 2001, and 2007, many Wall Street economists had predicted a soft landing for the U.S. economy. This summer, with signs of slowing inflation and a cooling labor market, some economists and Federal Reserve officials were optimistic that this elusive soft landing might be within reach.
However, this vision of a "soft landing" is now under significant strain.
With escalating strikes, an imminent U.S. government shutdown, and soaring energy prices, the S&P 500 Index experienced its worst month this year, marking its steepest monthly decline and the largest quarterly drop since the third quarter of last year.
Excluding the seven major stocks, including Apple and Microsoft, the S&P's gains this year would be cut by more than half, highlighting the market's extreme imbalance this year.
The U.S. dollar index recorded its longest weekly rise in 18 years and its longest streak of gains in nine years. Some Wall Street investors see this as a sign of the dollar being overbought.
Soft Landing or Bubble? Facing Triple Threats
Since September, the U.S. economy has been under continuous pressure, primarily from three sources.
Firstly, the U.S. government is on the brink of a shutdown, with partisan differences and internal Republican disputes making a shutdown increasingly likely. Joydeep Mukherji, Managing Director at S&P Global, mentioned in an email that compared to the earlier deadlock over the U.S. debt ceiling, a government shutdown wouldn't increase the risk of default. Such an outcome would impact economic activity but is unlikely to affect sovereign ratings.
Secondly, the U.S. auto industry strike continues to escalate. On Friday, media sources reported that the United Auto Workers (UAW) union would expand its strike due to a lack of consensus in labor negotiations. More factories from Ford, General Motors, and Stellantis will join the strike.
Lastly, international oil prices have been rebounding since the second half of the year. OPEC+ continues to intensify production cuts, and oil prices have risen nearly 30% during this period.
Tightening Policies Weigh on Stocks, Market Expects High Interest Rates
The Federal Reserve's consistent tightening monetary policy is continuously tightening the financial environment.
With the dollar soaring and long-term bond yields rising, the stock market has been on a decline for two months. Hedge funds and real estate investors have also reduced stock investments due to panic sentiment. Used car dealers and major retailers have issued warnings about their profit trajectories.
Multiple risk factors are collectively pushing the market to expect long-term high interest rates.
However, investors are not sitting idly by. Data from Deutsche Bank Group AG shows that investors who had over-allocated stocks earlier this year have now significantly reduced risk and moved towards a neutral position.
Despite the challenges, labor strikes and a government shutdown could help suppress price levels and slow inflation. Data shows that the Federal Reserve's preferred "underlying inflation indicator," the core CPI index, had its slowest growth in August in two years.
