Has U.S. Stock Turbulence Eased with 60% VIX Drop?

The past week in American stock markets has been nothing short of a rollercoaster ride,characterized by sharp rises and falls.Early in the week,trading was influenced by profit-taking activities,looming recession fears,and speculations about an emergency meeting of the Federal Reserve.However,these concerns seemed to dissipate in light of two key reports showcasing economic resilience in the services sector and labor market data.The anticipation of a soft landing for the economy also contributed to a decrease in expectations of Federal Reserve easing,with the Chicago Board Options Exchange's Volatility Index (VIX) retreating from its year-highs back towards long-term averages.

As the earnings season approaches its conclusion,investor focus has increasingly turned to economic data,suggesting that any signs of trouble might act as a trigger for the next wave of selling.

The outlook for Federal Reserve easing has cooled considerably.Following the unexpected weak labor data in July,last week's major reports did not shock the market.According to the U.S.Labor Department,for the week ending August 3,initial claims for unemployment benefits dropped by 17,000 to reach 233,000,marking the largest decline in nearly a year.This indicates that the labor market in the U.S.remains stable.Additionally,a report from the Institute for Supply Management (ISM) revealed that the services purchasing managers index (PMI) rose significantly in July from 48.8 in June to 51.4,going beyond market expectations and indicating expansion in the sector.

Bob Schwartz,a senior economist at Oxford Economics,noted in an interview that while the labor market has weakened somewhat since the start of the year,it still supports the case for a rate cut by the Federal Reserve in September,increasing the likelihood of a more aggressive policy shift.However,he cautioned that the rise in the unemployment rate in July may have exaggerated the slack in the labor market.

On a more positive note,Schwartz pointed out the encouraging details from the ISM report,which showed a notable rebound in business activity,new orders,and employment in July.Nevertheless,he warned against overreacting to one month's data; the focus should be on ongoing trends.Currently,the expansion in the U.S.services sector remains significantly above levels typically associated with economic recessions.

Amid ongoing pressures for potential emergency rate cuts,Federal Reserve officials have repeatedly emphasized their need to assess further economic data before making easing policy decisions.Boston Fed President Collins remarked that if economic data continues to develop as expected,it may soon be appropriate to begin loosening monetary policy."With a healthy labor market,my outlook is to continue gradually heading towards the 2% inflation target," he stated.Kansas City Fed's Jeff Schmid noted that U.S.inflation is cooling,setting the stage for potential rate cuts,but emphasized that the Fed has not yet fully achieved its goals.

These shifts in interest rate expectations have led to significant fluctuations in U.S.Treasury yields.The yield on the two-year Treasury rose by 18.2 basis points to 4.05% over the week,while the benchmark ten-year Treasury yield increased by 14.8 basis points to 3.94%.Earlier in the week,amid speculation about the Federal Reserve cutting rates by 50 basis points,the yield dropped briefly to around 3.70%.According to the CME Group's FedWatch tool,the probabilities for a 50 basis point rate cut compared to a 25 basis point reduction are now quite similar,with data approaching 80% late last week.

Michael Gapen,an economist with Bank of America Securities,expressed his belief that as concerns about a hard landing stabilize,the U.S.labor market will not collapse.He highlighted that forthcoming data will reveal what kind of economic slowdown the United States is facing: a gradual deceleration or a sharp decline.

Even amidst encouraging news about employment and services,Schwartz reiterated that the pressure from restrictive policies is likely to lead to a slowdown in U.S.economic growth in the latter half of the year,although he doesn't see it being catastrophic.Observers have recognized that earlier expectations for a substantial rate cut in September may have been excessive,with the traditional 25 basis point move likely being the initial step.Moving forward,financial markets will look to forthcoming economic data and remarks from Federal Reserve Chair Jerome Powell at the Jackson Hole conference.

Despite the easing of some volatility,the risks remain palpable.The adjustment that began in late July continues,with both the S&P 500 and NASDAQ indices experiencing declines for four consecutive weeks.Although the drop has moderated compared to earlier weeks,indicators of market volatility—like the VIX—are at levels not seen in nearly three years.

On Monday,the S&P 500 opened down 3%,marking its largest single-day decline since 2022,while the Dow Jones dropped over 1200 points at one stage.Subsequently,robust employment data attracted bargain-hunting investors,effectively alleviating prior fears of a recession,causing a close about two-thirds lower in the VIX from its highs.

Christopher Jackson,a senior vice president at UBS Wealth Management,commented,"In overall terms,we remain in an environment of economic slowdown—if not stagnation—with declining inflation.This doesn’t inherently forecast a recession.I believe the American economy will continue to grow moving forward,though not at last year’s pace." The recovery is tentative,particularly in sectors previously hard-hit,like technology.NVIDIA,a leader in artificial intelligence,remains in bear territory.

Nevertheless,the regulatory scrutiny for major tech companies continues to increase.Google is currently facing penalties for alleged monopolistic practices in the search market,while U.K.antitrust officials investigate whether Amazon's multi-billion dollar investment in AI firm Anthropic constitutes a competitive threat.This represents the latest attempt by European regulators to address the power and influence of American tech giants.

Terry Sandven,chief equity strategist at U.S.Bank Wealth Management,maintains that the underlying fundamentals are still favorable for the stock market,especially for investors looking toward the year's end and beyond.However,he warned that elevated levels of market volatility might become the norm rather than the exception given that market valuations remain high,coupled with seasonal trends that typically see lower returns in the summer doldrums.

Charles Schwab noted in its market outlook that the recent fluctuations are primarily due to two factors: the impact of interest rate hikes by the Bank of Japan on carry trades and rising probabilities of a U.S.recession.For bullish investors,the silver lining came when BOJ Deputy Governor Shinichi Uchida stated that the central bank would hold off on rate increases in times of market instability,easing the pressure on yen appreciation.However,several recession indicators—such as yield curve inversions and the Samuelson rule—have been triggered in the U.S.The S&P 500's forward price-to-earnings ratio is approximately 21 times,a level inconsistent with recession conditions,helping to explain the recent market unease.

The institution forecasts that given the current seasonal headwinds and the market's sensitivity to economic data,volatility could increase in the coming weeks.Upcoming economic data,including the July CPI,PPI,retail sales,and initial jobless claims,will be closely scrutinized.Overall,markets appear to be recovering from the panic selling phase,but the road to stability is not expected to be smooth.For investors,any negative economic surprise could quickly revert momentum back into bear territory.