Recession forecasts crushed as economy defies doomsayers

Wall Street's recent recession forecasts were hammered this week as data on jobs, consumer spending, inflation, and small business optimism all pointed to an economy that will continue to expand firmly into the autumn months.

The Commerce Department reported Thursday that retail sales were 1% higher in July, notching the best monthly gain in more than two years. Consumers spent more than $709 billion on everything from cars and appliances to food and clothing.

The stronger-than-expected reading echoed a bullish near-term forecast from the world's biggest retailer, Walmart ( WMT ) , which posted Street-beating sales of just over $169 billion and lifted its full-year profit forecasts, adding that it continues to see firm spending trends over the first two weeks of August.

Related: Walmart stock soars to record high on Q2 earnings, profit forecast

"We see, among our members and customers, that they remain choice, discerning, value-seeking, focusing on things like essentials rather than discretionary items," said Walmart CEO Doug McMillon. "Importantly, we don't see any additional fraying of consumer health."

Meanwhile, weekly jobless claims data from the Labor Department showed that the number of Americans filing for first-time unemployment benefits fell by 7,000 to 227,000, a tally that came well inside Wall Street estimates and could assuage concerns of a slowing labor market.

Earlier this week, a key reading of small business optimism from the NFIB came in at the highest level in two years, while last week, ISM data on service sector activity over the month of July showed the fifth month of expansion so far this year.

Defying Wall Street 'doom and gloom'

Collectively, the data tests Wall Street's recent recession forecasts, which were partly tied to last month's payroll report and concerns of a hiring slowdown heading into the back half of 2024.

"Today’s retail sales numbers were a blowout versus consensus, but more importantly, it should lay to rest (at least for the moment) all of the doom and gloom that was expressed at the beginning of this month," said Chris Zaccarelli, chief investment officer for the Independent Advisor Alliance.

Economists have grown concerned that elevated Federal Reserve interest rates, which act as a benchmark for domestic consumer and business borrowing costs, will continue to drag on broader economic growth.

Related: Main Street businesses push back on Wall Street's recession gloom

However, with the Commerce Department's July CPI inflation report showing price pressures fell below the 3% level for the first time in more than three years, bets on a September rate reduction have accelerated quickly, with traders pricing in the odds of at least a 25 basis point cut at around 75%.

Meanwhile, the Atlanta Fed's GDPNow forecasting tool indicates a current quarter advance of 2.4%, down from the prior estimate of 2.9%, largely as a result of a change in private inventories. The Commerce Department's estimate for growth over the three months ending in June was last pegged at 2.8%.

Economic soft landing boost for stocks

"If the economy continues to be resilient – especially in conjunction with slowing inflation – then the Fed can begin a rate-cutting cycle without the economy entering recession and history shows this is an extremely positive environment for the stock market," Zaccarelli said.

U.S. stocks were trading firmly higher after the retail sales and jobless claims data, with the S&P 500 turning positive for the quarter and rising to the highest levels since July 19.

Perhaps more importantly, the CBOE Group's VIX index, the market's benchmark volatility gauge, fell to the lowest levels in more than a month.

"We’re back to an environment where good news is good news, and bad news is bad news. Investors and consumers want inflation to go lower, but not at the expense of the economy," said Brent Kenwell, U.S. investment analyst at eToro. "Today’s stronger-than-expected retail sales figure quiets some of the recent fears that the US may be slipping into a recession."

Related: Wall Street banks ring recession alarm

Data from the manufacturing sector, however, continues to suggest that springtime weakness could extend into the summer and beyond.

Readings for both industrial production and manufacturing output slipped lower last month, according to Commerce Department data published Thursday, while indices tracking activity in the New York and mid-Atlantic regions for the month of August were mixed.

Manufacturing still muted

"The bottom line here is that manufacturing is in less-bad shape than at the turn of this year, but it would be a stretch to argue that the surveys point now to a meaningful strengthening," said Ian Shepherdson of Pantheon Macroeconomics. "Monetary conditions remain extremely tight, especially for smaller firms, and global demand is rising only slowly."

Investors are now likely to shift focus to a series of late-August events that will clarify the Fed's likely rate path and gauge sentiment on one of the market's most important stocks.

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Federal Reserve Chairman Jerome Powell will deliver a keynote address to the central bank's annual symposium in Jackson Hole, Wyoming on August 24, while the Fed's preferred inflation measure, the PCE Price Index, will be released on August 29.

Sandwiched between those two events will be AI chipmaker Nvidia's ( NVDA ) hotly-anticipated second-quarter earnings, which are sure to act as a barometer for technology spending forecasts and broader market sentiment heading into the final months of the year.

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