Many Canadians went into the weekend looking to unwind—camping, road trips, watching the Olympics, those sorts of things.

The financial markets had other plans.

On Friday, the S&P 500 dropped 1.8%, then again on Monday by 3%. Some of those losses were recovered yesterday, but the U.S. market is still well down from Thursday’s close. Bond yields dropped, pricing in greater probability of interest rate cuts.

With Canadian markets closed Monday, the S&P/TSX followed suit yesterday, falling 1.1%.

What just happened? The world is a complicated place and I don't intend to capture everything, but here are some ‘big picture’ themes.

The coveted soft landing

Let's rewind the clock a couple years. When the U.S. Federal Reserve (the Fed) started raising interest rates to fight inflation, there were widespread fears of a recession.

That didn't happen. In fact, the U.S. economy grew 2.5% last year, and recorded 2.8% annualized growth in the second quarter of 2024. The labour market had also performed well.

The word 'recession' was  replaced with 'resiliency'.

Threading the needle

Hope spread that the Fed would pull off the impossible: slow the economy just enough to get inflation back on track, but without causing major damage.

The Fed’s median “dot plot” projections from June pegged the unemployment rate at only 4.2% next year with real GDP growth of about 2% this year and next year. That's a soft landing, if you want to call it a landing at all.

Then last Wednesday, more seemingly good news. The Fed held the line on rates (as everyone was expecting), but it was a ‘dovish hold’. The Fed opened the door to a rate cut in September, noting progress on inflation. Finally, rate cuts were within sight.

Disappointed by data

Yet markets remained on high alert for any hint that the landing may not be so soft.

Just a day after the Fed announcement, U.S. jobless claims came in higher than expected. But it was Friday's labour market report that really pushed markets over the edge. The unemployment rate rose to 4.3% and employment rose only 114,000 - below expectations. Not a disastrous report, but for jittery markets, not up to snuff.

Another indicator received attention. Economist Claudia Sahm's now famous "Sahm recession indicator" was triggered. Her indicator, based on movements in the unemployment rate, has a perfect track record of predicting past recessions. Sahm acknowledged it’s a worrisome situation, but also that it doesn’t necessarily mean a recession (in part because much of the increase in unemployment is due to labour force growth as opposed to job losses).

Equity markets fell on the disappointing labour market news. It was made worse by some technical features, like the fact that markets had already gone on a decent run, pressure on the Magnificent 7 tech stocks, and the unwinding of the so-called carry trade.

Buckle up

Expect more turbulence.

The markets will be looking for any signs of what type of landing this will be: soft, softish, or hard. Keep in mind that U.S. fundamentals have not changed that much in the last few days. Indeed, unemployment is still relatively low, and the latest GDP growth numbers are solid. It could be that market optimism got ahead of itself and is just coming back to reality.

What all this has solidified, in our view, is a shift to lower rates sooner rather than later. A first rate cut by the Fed (possibly even a ‘super’ 50 basis points) in September, and another Bank of Canada cut in September of 25 basis points is our call.

In the meantime, keep a close eye on key upcoming data points: for Canada, the next big release is this Friday’s labour market report.

Answer to the previous trivia question: The population of Paris was 2.1 million as of January 2023 with the Paris Region home to about 12.3 million people.

Today’s trivia question: At $134 million, where did France rank on the list of Alberta’s merchandise exports by country last year?