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The US economy is at an important moment ahead of this Friday's jobs data release, which could trigger a "vicious feedback loop" between the markets and the economy, analysts at Nomura wrote in a note published on Wednesday.
This refers to a situation where negative news can drag markets lower — which in turn creates more negative news.
"We could be at a critical juncture: If this Friday's job report surprises by weakening further, and the equity market selloff deepens, we may not be far from triggering this vicious feedback loop," wrote Nomura research analysts Rob Subbaraman and Yiru Chen in their note titled "Market fear of recession could inadvertently cause it too."
They based their assessment on a comparison with the dot-com crash that came before a recession in April 2001.
At the time, the S&P 500 and Nasdaq indexes fell by 24% and 56%, respectively, from their peaks in August 2000 to their troughs in March 2001.
Meanwhile, the ISM Manufacturing Index fell and stayed below the 50 level from August 2000 until February 2002, indicating factory activities were in a contractionary mode.
The unemployment rate was stable at 3.9% before jumping to 4.2% in January 2001.
During the dot-com crash, the Fed started cutting interest rates in January 2001 — four months into the stock market correction, the Nomura analysts noted.
Over the entire year in 2001, the Fed slashed the Fed funds rate by 475 basis points. It also warned of a negative feedback loop between the falling equity market and a weakening economy, wrote analysts.
They cautioned that it could happen again — now.
Like before the dot-com crash, household net worth as a percentage of disposable income has risen substantially, and the ISM manufacturing index is in contractionary territory.
Investors have been jittery since Tuesday, when the stock market saw its worst loss since a massive sell-off in early August.
This time, the US unemployment rate has risen sharply from 3.7% in January to 4.3% in July — and it is this data that could spur the Fed to slash rates, the analysts added.
"When vicious feedback loop forms between falling asset prices and a weakening economy — via negative wealth, confidence and loan collateral effects — the Fed responds more rapidly and forcefully," the analysts wrote.
