The US may be 'sleepwalking' into a recession as cracks form in the labor market, top economist says

• The economy is flashing warning signs that suggest a downturn is on its way, according to David Rosenberg.
• The top economist pointed to a weakening job market and a slowdown in manufacturing activity.
• Several financial models are already sounding the alarm for a hard-landing, he noted.

The US could be "sleepwalking" into a recession, and signs of a downturn in key areas of the economy are starting to show, according to top economist David Rosenberg.

The Rosenberg Research president pointed to a handful of warning signs that a slowdown is on the horizon. That's contrary to how most investors feel on Wall Street, with optimistic sentiment building as data continues to show a stable economic picture. 

"We're constantly asked when we're planning to throw in the towel on our recession call, but perhaps it's time folks started asking when the rest of the street is going to pick their towels back up," Rosenberg said in a note this week. "We've seen a downshift in the data flow that are starting to indicate that the downturn in the economy may not be as far away as many believe."

The job market, for one, has continually weakened over the past year. The unemployment rate remained near a two-year-high in April, ticking up to 3.9%. That means the job market is even closer to triggering the Sahm Rule, a "gold standard metric" of a coming recession that flashes when the three-month moving average of the unemployment rate rises 0.5% above its 12-month low, Rosenberg said.

Economic activity is also starting to slow. GDP came in softer-than-expected over the first quarter, with the economy growing by 1.6%, well below the previous two quarters' growth. 

Manufacturing activity contracted in April, the 17th contraction recorded out of the last 18 months. That's a strong sign the economy is weakening, as manufacturing has only contracted on two occasions since 1997 without the economy later slipping into recession, Rosenberg noted.

Popular recession models have already signaled a downturn may be on the way. The 2-10 Treasury yield curve, a notoriously accurate recession indicator, has signaled a coming downturn since July 2022. 

The full model, which estimates the probability of recession over the next 12 months, is showing that the US still has nearly a 50% chance of tipping into recession over the next year.

"Don't get complacent. The labor market is cracking, a slowdown in services activity is dragging on real-time growth, and forward looking financial signals still point to a coming slowdown," Rosenberg said.

Rosenberg has been warning of a coming recession for months — and fears of a downturn are rising as investors anticipate the Fed keeping interest rates higher-for-longer. Higher rates risk overtightening the economy and sparking a recession, and markets are now pricing just one or two rate cuts by the end of the year, according to the CME Fedwatch tool.