For much of 2024, it appeared the Federal Reserve had successfully navigated a tricky line, tempering the hottest inflation in four decades while keeping the U.S. economy from sinking into a recession. But recent weak economic data is prompting some economists to caution that the nation isn’t out of the danger zone just yet.
One economic indicator sparking fears of a so-called hard landing was the disappointing jobs report on August 2, which showed that the unemployment rate jumped to 4.3% in July from 4.1% in the prior month. That climb triggered the Sahm Rule, or when the three-month moving average of the national jobless rate rises 0.5 percentage points above its prior 12-month low.
Because the Sahm Rule has historically signaled the start of a recession, Friday’s data fueled a three-day market rout that led to the S&P 500’s worst trading day in nearly two years. Economists, meanwhile, say that while the Sahm rule doesn’t appear to be accurate this time around in calling a recession, they are seeing rising risks the economy could slip into a contraction.
“It’s not that the macroeconomic fundamentals are much weaker,” Gregory Daco, chief economist at EY-Parthenon, told CBS MoneyWatch. “But given the tightening of financial conditions, the likelihood of a recession has increased.”
Other economists are also flagging the heightened possibility of a recession, with Goldman Sachs on August 7 increasing its 12-month recession risk from 15% to 25%. Goldman cited the jump in the unemployment rate, noting that “even such a modest increase has been a reliable recession indicator in postwar U.S. business cycle history.”
What is the Sahm Rule?
The Sahm Rule was created by Claudia Sahm, the chief economist at New Century Advisors and a former Federal Reserve economist, who first outlined the indicator in a 2019 book published by the Brookings Institution’s Hamilton Project.
In a 2022 blog post, Sahm wrote that the idea was to create a policy tool that would help the government determine when to send out stimulus checks, but she noted wryly that the rule took on a life of its own, drawing attention from noted economists like Larry Summers and the media.
“I created a monster,” she wrote in the 2022 post, adding that the rule “is a historical pattern, not a rule of nature.”
Since the Sahm Rule was triggered last week, she’s underscored that point, writing on Wednesday in Bloomberg News that she doesn’t believe the U.S. is in a recession. Her rule, she added, is just one of multiple indicators that have been “disrupted” by the unusual economy of the last four years.
The Sahm Rule can be helpful as a potential forewarning of a recession before it’s called by the National Bureau of Economic Research (NBER), the organization that makes the official designation of when the U.S. has entered or leaves a recessionary period, Daco noted. Typically, a recession is defined by a decline in economic activity that lasts more than a few months, the NBER says. But the U.S. economy is still chugging along, with second-quarter GDP growing 2.8%, faster than economists had expected.
The Sahm Rule isn’t tracking this time around because unemployment rose due to an increase in the labor pool, Daco noted — not because companies are firing workers. The jobless number can increase if there are more workers exiting the workforce than entering it, and if not all of the latter find jobs.
“Even though today we’re not in a recession, the trajectory of the U.S. is one of a slowdown,” Daco noted. “Whether payrolls, the unemployment rate, layoffs, they all point to a slowdown in employment.”
How does a recession start?
Recessions can start in a number of ways, from financial imbalances, such as the collapse of the housing market in 2006, to an economic shock, like the pandemic shutting down global business in 2020.
But economists are now concerned about a rising recession risk stemming from the tight financial conditions faced by many businesses and consumers: While the Fed was battling inflation by hiking interest rates to their highest point in 23 years, those hikes have increasingly been straining Americans seeking loans to buy property or carrying credit card debt.
The recent market rout could feed into those issues as well if it undermines confidence in the economy, causing businesses to cut jobs or hold off on hiring while making consumers hesitant to spend money, Daco added.
“If financial conditions tighten and consumers and businesses take fright, there could be a pullback in investment and consumer spending that could lead to a recession,” he noted. “The combination of all these factors can lead to the feared recession materializing.”
The Fed’s next move
Despite concerns of mounting risks, most economists believe the probability of a recession remains small, with Goldman Sachs noting that “continued expansion is far more likely than recession.”
And Thursday delivered a more positive economic indicator, with new claims for unemployment benefits falling to their lowest since early July, the Department of Labor said. The latest data cheered Wall Street and helped boost the S&P 500 by more than 2%.
Economists and investors, meanwhile, are focused on the Federal Reserve’s next rate decision meeting on September 18. Chair Jerome Powell last month opened the door to a rate cut next month, on the condition that “we do get the data we hope to get,” meaning numbers showing that inflation continues to cool.
The majority of economists polled by FactSet are penciling in a rate cut of 0.5 percentage points, or double the typical rate cut, due to the weakening labor market, followed by additional reductions at its November and December meetings. Lowering borrowing costs could ease some of the pressure felt by businesses and consumers, providing more breathing space to hire or make purchases.
With rates at their highest in more than two decades, the Fed has a lot of room to cut, experts note.
“The Federal Reserve has plenty of scope to support the economy and markets,” noted Solita Marcelli, chief investment officer Americas at UBS Financial Services, in an August 6 report. “Recent data has improved confidence that inflation is headed sustainably back toward the 2% target, freeing the Fed to focus more attention on supporting growth and employment.”
Reprinted from “CBS NEWS”
