FORECASTS & TRENDS E-LETTER
By Henry Rohlfs
April 9, 2024

That is Sahm Kinda Recession Indicator

IN THIS ISSUE:

1.  Powell Holds the Line

2.  Nothing New in the JOLTS Report

3.  Unemployment Also Steady

4.  Introducing the Sahm Rule

5.  A Final Thought

The Federal Reserve has two mandates: achieving maximum employment and keeping prices stable. It does this by controlling the money supply and raising or lowering interest rates. The Fed’s fight against inflation has been a common topic in financial news for several months, but not as much coverage has been given to the job market. The economy as a whole has remained robust in this high inflation environment, which has kept unemployment comparatively low.

I thought it might be interesting to look at a little-known recession indicator the Fed uses that is entirely based on unemployment numbers. It’s called the Sahm Rule and we’ll take a look today at whether it is signaling recession.

But before we start on that discussion, let’s take a quick look at the Personal Consumption Expenditures index as reported last week and if it has caused Jerome Powell to change his narrative regarding upcoming interest rate cuts by the Fed.

Powell Holds the Line

Federal Reserve Chair Jerome Powell doubled down last week on his belief that inflation was on a "bumpy" path down to 2% and central bank officials expect to lower rates at "some point" this year.

Powell also once again asserted the Fed would maintain its independence during this red-hot election year, noting that its analysis is free from any "personal or political bias."

Such data does not "materially change the overall picture, which continues to be one of solid growth, a strong but rebalancing labor market, and inflation moving down toward 2% on a sometimes bumpy path," Powell said in a speech delivered at Stanford University.

A new inflation report released last Friday showed a slight cooling in the Personal Consumption Expenditures (PCE) index, which is the Fed's preferred inflation gauge. After the release, Powell said the PCE result was "definitely more along the lines of what we want to see."

The PCE reading followed persistent inflation data in January and February from other gauges, such as the Consumer Price Index. The next CPI reading will be released tomorrow and many economists predict it to be in the 3.2-3.4% range, slightly higher than previous months. This result would reinforce the possibility that Fed rate cuts will not begin until the second half of 2024.

Nothing New in the JOLTS Report

The JOLTS report – Job Openings and Labor Turnover Survey – for February 2024 was released by the Bureau of Labor Statistics (BLS) last Tuesday. The bottom line is the U.S. labor market is holding steady.

Here are the numbers. The number of job openings changed little at 8.8 million. This is down from a high of 12.2 million in March 2022. Most openings remain in the healthcare, business and hospitality sectors.

Over the month, the number of hires and total separations were little changed at 5.8 million and 5.6 million respectively. Total separations include quits, layoffs and discharges. Quits are generally voluntary separations started by the employee, while layoffs and discharges are involuntary separations initiated by the employer. The quits rate can serve as a measure of workers’ willingness or ability to leave jobs. Within separations, quits (3.5 million) and layoffs and discharges (1.7 million) changed little in February.

Unemployment Also Steady

The US economy added 303,000 jobs last month, according to data released last Friday by the Labor Department. That blew past expectations for 205,000 job gains, according to FactSet consensus estimates. The unemployment rate fell a bit to 3.8% from 3.9% the prior month.

This indicates the job market is holding steady and not slowing down. Nick Bunker, Indeed Hiring Lab’s economic research director, said in a statement, “March’s jobs numbers were uniformly strong, and upticks in the employment-population ratio and labor force participation in particular suggest that demand for workers is not outstripping supply, like it was a few years back.”

Introducing the Sahm Rule

Looking past unemployment data, the U.S. Treasuries yield curve has been inverted since 2022, as longer-term yields on government debt are lower than shorter term rates. Yield curve inversion is often heralded as a recession indicator, although it has been wrong so far this economic cycle.

Claudia Sahm, while working as an economist with the Federal Reserve, proposed a different approach to identify the onset of a recession. Her observations suggest that if the 3-month average unemployment rate rises by half a percentage point (0.50%) from its lowest level in the preceding 12 months, the economy is in a recession or will enter one soon.

The beauty of the Sahm Rule is in its simplicity and low rate of false positives. You can see from the graph below that the Sahm recession indicator has accurately predicted recessions since the 1960s. While the indicator is a recession predictor well ahead of the formal National Bureau of Economic Research (NBER) recession indicators, it can take about three months to register a recession. That is far sooner than the six-month to two-year retrospective indication from the NBER.

This indicator is based on "real-time" data, that is, the unemployment rate (and the recent history of unemployment rates) that were available in a given month.

Let’s see what the Sahm Rule indicates now. In March 2024, the Sahm recession indicator was 0.30%, meaning the three-month average unemployment rate is 0.30% above its low for the previous 12 months. This is a slight increase from February’s value of 0.27%.

So currently, the Sahm Rule indicates a “normal” risk that we are currently in a recession. I recently heard Claudia Sahm interviewed, and she was very surprised at the resounding predictions of eminent recession. She said the Sahm Rule gave her the “credibility to be a voice of reason and calm.”

A Final Thought

We are starting to hear the drumbeat that recession will arrive in 2025. Research by the Federal Reserve Bank of New York currently puts the probability of a U.S. recession by March 2025 at 58%. Economist David Rosenberg in an interview with Business Insider believes there’s an 85% chance of recession by the end of the year. "Our conviction that the recession has been delayed but not derailed is still running at a high level," Rosenberg said.

It is still too early to see if the Fed will pull off a “soft landing” or even “no landing” in the next several months, or if a recession is on the horizon. But it is clear the FOMC is in no hurry to drop interest rates.

All the best,

[Henry]

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