Investors have been increasingly concerned regarding a potential recession in the fiscal third quarter, after a worse-than-expected economic contraction in the first quarter and expected deceleration in jobs growth. 

The Bureau for Economic Analysis (BEA) released its third fiscal 2022 first-quarter GDP estimate earlier this week, indicating a worse-than-expected contraction of the U.S. economy. 

The new economic data states that the US economy shrunk by 1.6% on an annualized basis in the first three months, down from the initial 1.4% contraction reported in the April 2022 estimate. In comparison, analysts expected the quarterly GDP to improve by 1% on an annualized basis, as per Dow Jones consensus estimates. 

The third GDP revision has deterred investors substantially, stoking recession fears. Typically, a GDP decline in two consecutive quarters indicates a recession. As the Fed reiterates its aggressive hawkish stance with a potential 75 basis point rate hike this month, recession fears have catapulted in the second half of the year. 

Bearish investor sentiment has already dragged stock market indices lower in 2022. The S&ampP 500 (AMEX: SPY) index is down 20% in 2022. Comparatively, the NASDAQ Composite index and Dow Jones Industrial Average index have fallen 30% and 15% year to date. 

 

Decelerating job growth 

One of the most significant indicators of recession is decelerating job growth. Investors are currently eyeing the monthly jobs report for June, which is scheduled to be released this Friday, July 8th

The Dow Jones consensus estimate of 250,000 non-farm payrolls reflects a steep decline from the 390,000 non-farm payrolls reported in May. Though the labor market is expected to remain strong, economists are predicting a declining employment growth rate due to the aggressive rate hikes and quantitative tightening. 

The employment component of the ISM June manufacturing survey stood at 47.3, indicating economic contraction. 

Moreover, the head of macro-economic research at AXA Investment Managers, David Page, expects non-farm payrolls to be in the range of 150,000-250,000 by the early third quarter.  

Regarding this, he said, “That’s part of a trend we’re seeing emerge. It’s very evidently a slowdown in the economy … The warning signs are starting to emerge, and the more we see those warning signs start to trickle into the labor market, the more the Federal Reserve is going to have to take heed and that’s what puts such focus on next Friday’s payroll report.”

 

Rate hikes might drive S&ampP 500 lower

The Federal Reserve increased the benchmark federal funds rate by 75 basis points earlier in June, the largest hike since 1994. Economists had earlier polled another 75-basis point rate hike in July, as the inflation remains high. However, the latest GDP data released by the BEA indicates an economic contraction. 

If the employment data scheduled to be released this Friday points toward a potential recession, the Fed might reconsider its 75-basis point rate hike expected in July. Page expects the Fed to rethink a 75-basis point hike in its policy meeting in July. 

If there are credible signs that the economy is slowing down, then Powell might end up raising the federal funds by only 50 basis points. This would increase the chances of a “soft landing.”

On the other hand, if the employment data is strong, the Fed might be required to double down on its rate hike policy.

Rising interest rates have already driven growth stocks significantly lower in 2022 as it is expected to result in lower profit margins and earnings per share. 

The BEA had initially estimated the United States to have contracted by 1.4% in the fiscal 2022 first quarter, which was then revised twice to indicate a 1.6% decline. This, coupled with lower consumer spending and surging inflation, has caused recession fears to skyrocket. The Atlanta Fed GDP tracker indicates the US is already in recession, as the GDP is expected to decline 2.1% in the second quarter.

SPDR S&P 500 (AMEX:SPY)
Historical Stock Chart
From Nov 2022 to Dec 2022 Click Here for more SPDR S&P 500 Charts.
SPDR S&P 500 (AMEX:SPY)
Historical Stock Chart
From Dec 2021 to Dec 2022 Click Here for more SPDR S&P 500 Charts.