The July jobs report just set off an important recession indicator that is closely watched on Wall Street.
However, the person who made it doesn’t believe that the U.S. economy is in a recession at the moment. And Jerome Powell, the head of the Federal Reserve, said the indicator doesn’t mean anything in particular.
First, let’s look at the numbers: the unemployment rate hit 4.3% in July. The three-month moving average of the unemployment rate is at least 0.5 percentage points higher than the lowest three-month average from the previous year. As per the Sahm rule, when the level of 0.5% is reached, there is a recession.
To break that down further, the rule basically says that the economy is in a slump when the unemployment rate is rising quickly. The three-month average is important because it evens out times when the unemployment rate changes for one month because of a strange event.
The rule, which is named for Claudia Sahm, a former Federal Reserve economist, is closely watched because it has worked in the past.
This chart from Bank of America shows past readings and how accurate they were in the past. Most of the time, a recession has already begun when the unemployment rate goes up by 0.5 percentage points. One time this didn’t happen was in 1960, but the recession did begin five months later that year.
How about now?
The CEO of Sahm told the Wall Street Journal that she doesn’t think the economy is in recession. She says that the recent rise in immigration and changes in the labour supply after the pandemic have made it less useful.
Still, she is worried about the U.S. economy’s direction, and Sahm had said before Wednesday’s Fed decision that the bank should lower interest rates.
Two days after the Fed meeting, new data suggests that the central bank should have listened. The unemployment rate going up is just one sign; other signs include the ISM manufacturing activity index going down and the number of first-time jobless benefit claims going up.
Bond yields BX:TMUBMUSD10Y have dropped sharply, and stock prices SPX 1.84% have also gone down.
Powell, the head of the Federal Reserve, was asked if the Sahm rule might be used on Wednesday.
“I would just say that the question is whether we are worried about a sharper drop in the job market,” Powell said. “And the answer is that we’re keeping a close eye out for that.”
He said that the Sahm rule was “just a fact of statistics; it’s not like an economic rule that says something has to happen.”
Powell also said that the job market seems to be “normalising.”
To be exact, the Federal Reserve says that the job market is now off the charts. The Fed thinks that the long-term unemployment rate will be 4.2%. Right now, the rate is a tenth of a percentage point higher than that.
But that doesn’t mean the U.S. economy is in a recession. The National Bureau of Economic Research says that an economic recession is a big drop in activity that affects the whole economy and lasts for more than a few months.
There is no set rule for what counts as a recession or not. Instead, the NBER has a committee of economists make the decision.
But the group focusses on a few indicators in particular. These are nonfarm payrolls employment, personal income adjusted for inflation excluding transfers, consumer spending adjusted for inflation, and industrial production.
When compared to the same time last year, none of them have gone down.
