Concerns about the United States falling into recession are gaining momentum! Is another storm approaching?

The uncertainty of the US economic outlook and the seasonal weakness of stocks have together created another "perfect storm" of violent market fluctuations globally, with investors scrambling for protection and fearing a new round of monetary chaos.

After the chaotic sell-off in early August and the rapid rebound of risk assets, traders have lost the brief optimism that the Fed rate cut would support growth.

Instead, they seem to be anticipating a replay of last month's disastrous scenario with Friday's US employment data, exacerbated by weak US manufacturing data on Tuesday, triggering new sell-offs.

On Tuesday, the S&P 500 index fell by over 2%, while Japan's Nikkei index plummeted by 3.7% on Wednesday, marking the largest single-day drop since the market crash on August 5th, with European stock markets also sharply declining.

At the same time, the VIX index, which measures expected volatility in the US stock market, has risen to a one-month high, with volatile currency trading threatening the US dollar and other safe-haven currencies.

"The market is dealing with uncertain inflation, but growth remains strong," said Florian Ielpo, head of macro at Lombard Odier. "However, this situation seems to be changing, with new uncertainty being the extent of the economic slowdown."

The turbulent start to September follows the global crash in early August, when Japanese rate hikes and US employment data disrupted popular carry trades betting on a weakening yen.

Echoing the pain of August, heavily crowded tech stocks with overvalued valuations are taking a beating. AI giant NVIDIA fell by 9.5% on Tuesday, marking the largest single-day market cap drop for a US company. Dutch semiconductor equipment supplier ASML Holdings fell by around 5% on Wednesday.

"One of the biggest risks is the high concentration in the market, where any volatility in one large tech company will affect the entire market," said Justin Onuekwusi, Chief Investment Officer at investment firm St. James' Place.

This volatility comes after concerns among investors about different narratives for stocks and bonds in early September, with the stock market already pricing in strong corporate earnings, while government bonds rebound amid expectations of a significant US rate cut and recession risks.

"You now need to decide whether you like credit and bonds or stocks," said Ielpo, adding that he has been buying government bonds over the past four weeks.

The yield on the US 10-year Treasury bond is around 3.8%, having been declining over the past four months. On Wednesday, German bond yields further retreated from the near one-month high touched on Monday.

BCA Research recommends selling stocks and buying bonds. The institution stated in a client report, "We believe there is a high likelihood that we are currently at the threshold of an economic recession."

The Fed is expected to cut rates for the first time since 2020 on September 18, with the money market currently pricing in a 43% chance of a 50 basis point cut to 4.5%-4.75% in the federal funds rate A widely followed index measuring the performance of high-yield corporate bonds has also risen by 2.5% since a brief dip in early August.

Darpan Haran, a credit fund manager at Ninety One, expressed caution towards US high-yield bonds, citing the weaker financial condition of the borrowers which makes them vulnerable to economic shocks. "Due to valuation and concerns about a US recession, US high-yield bonds are more prone to repricing."

Dollar Volatility

Analysts suggest that traditional safe-haven currencies may not perform well in this global sell-off, as there is uncertainty whether the US dollar will maintain its usual attractiveness during a decline in risk assets, or suffer losses as traders anticipate an upcoming US economic recession.

Short-term speculators have placed bets of around $9 billion on the US dollar weakening against other major currencies, which could lead to larger foreign exchange fluctuations if proven wrong, or further weaken the US stock market if proven right.

Alex Jekov, G10 FX strategist at BNP Paribas, mentioned that trend-following CTA funds were key participants in the August market sell-off, having built up significant bets on a weaker US dollar.

If US employment data this week is strong, the dollar could strengthen, prompting a rapid exit from those short positions and impacting currencies currently favored by speculators, such as the pound. The FX volatility index is rising back to the peak levels seen in early August.

Kit Juckes, Chief FX Strategist at Societe Generale, noted that in the long term, the US dollar and US stock market could drag each other down, as there is a significant inflow of funds from overseas into Wall Street stocks without currency hedging. He stated:

"The risk for the dollar is that not only will people sell the dollar, but they will also sell US stocks."