The recent July jobs report has invoked one of the most renowned and historically accurate recession indicators, the Sahm Rule, prompting heightened concern among investors and economists. This rule, devised by Claudia Sahm, triggers when the current three-month moving average of the unemployment rate surpasses the lowest three-month moving average of the past year by 0.5 percentage points or more. On Friday, the activation of the Sahm Rule led to a significant market reaction, but Sahm herself has pushed back against the notion that a recession is imminent.
Understanding the Sahm Rule and Recent Data
The Sahm Rule is designed to identify potential recessions based on unemployment trends. According to this rule, when the unemployment rate’s three-month moving average exceeds the lowest such average from the previous year by at least 0.5 percentage points, it signals the likelihood of a recession. Recent Bureau of Labor Statistics data showed that the unemployment rate increased from 4.1% in June to 4.3% in July. This uptick pushed the Sahm Rule’s reading to 0.53%, up from 0.43% in June, thereby activating the rule and suggesting that economic slowdowns could be on the horizon.
Despite this trigger, Claudia Sahm, now Chief Economist at New Century Advisors, cautioned against jumping to conclusions about an impending recession. She highlighted that key economic indicators such as household income, consumer spending, and business investment remain strong and resilient. Sahm attributed the increase in the unemployment rate partly to the entry of 420,000 new workers into the labor force in July, which could distort the unemployment metrics. She also suggested that recent fluctuations in the labor market due to labor shortages and increased immigration might affect the accuracy of the Sahm Rule’s signal.
Market Response and Economic Implications
The market’s reaction to the Sahm Rule’s activation was swift and severe. On the day the report was released, major indices experienced sharp declines: the Dow Jones Industrial Average fell by 1.5%, the S&P 500 dropped by 1.8%, and the Nasdaq Composite plunged 2.4%. This market selloff reflects investor anxiety over the potential for economic downturn.
Following the release of the July jobs report, which indicated broader employment slowdowns, Rick Rieder, Chief Investment Officer of Global Fixed Income at BlackRock, suggested that a rate cut by the Federal Reserve in September is increasingly likely. Rieder, who manages a substantial portfolio of fixed income assets, argued that the Fed’s current interest rate of 5.375% may be too restrictive given the lower inflation rate and emerging slack in the labor market. He suggested that the Fed should have already begun cutting rates to better support economic growth.
Sahm concurred with the view that the Fed should consider rate cuts but emphasized caution in interpreting the Sahm Rule’s signal. She acknowledged that while the rule has been historically accurate in predicting recessions, current economic conditions may present unique challenges. She argued that the Fed must address potential further weakening in the labor market and consumer spending, balancing this with its dual mandate of maintaining maximum employment and controlling inflation.
Federal Reserve’s Stance and Market Expectations
Fed Chair Jerome Powell has been cautious in his responses to the Sahm Rule, describing it as a “statistical regularity” rather than a definitive economic forecast. Powell has maintained that the labor market is “normalizing” rather than deteriorating. Nonetheless, he has indicated that the Fed is closely monitoring for signs of a more pronounced economic downturn.
Market analysts, including Elyse Ausenbaugh from JPMorgan Wealth Management, have noted that the market’s reaction to the jobs data suggests concerns that the Fed may be lagging behind in its policy adjustments. Ausenbaugh and others in the financial community now view a September rate cut as highly probable, with debates focusing on whether it will be a 25 or 50 basis point reduction.
Sahm believes that the Fed should have already implemented rate cuts and anticipates that a significant reduction might be necessary in September if economic data continues to show broad slowing. She argued that with inflation rates falling, the Fed has room to support the labor market through rate cuts, potentially helping to stave off a recession.
Broader Perspectives and Economic Forecasting
Sahm also stressed the importance of a holistic approach to economic forecasting, cautioning against over-reliance on any single indicator like the Sahm Rule. She acknowledged that while the triggering of the Sahm Rule is a signal of potential economic issues, it should not be viewed as an immediate predictor of recession. Instead, it should be one of many factors considered in evaluating the overall economic landscape.
In conclusion, while the activation of the Sahm Rule has raised concerns about a potential recession, Claudia Sahm and other experts emphasize the need for a nuanced understanding of current economic conditions. The focus should be on broader economic trends and the Federal Reserve’s policy responses rather than solely on recession indicators. The potential for a significant rate cut by the Fed in September, as suggested by recent market expectations, may play a crucial role in shaping the economic outlook moving forward.