Authoritative recession indicator "flashes red light", but the creator warns: Don't panic yet!
Authoritative recession indicator "flashes red light", but the creator warns: Don't panic yet!
The founder of Sahm Consulting admitted in an article on Substack that with the weak labor demand, the risk of economic recession is definitely rising. However, she believes that this is largely due to the lagging effects of an overheated economy, with the labor outflow known as the "Great Resignation" leading to a shortage of talent in companies.
While an increase in the number of job seekers unable to find work is a necessary condition for economic contraction in the United States, Sahm pointed out that other indicators are not consistent with a general weakness in economic activity, including consumer spending and another key labor market data: nonfarm payroll employment.
She wrote last Friday, " Although the Sahm rule is about to be triggered, an economic recession is not imminent."
Named after Sahm herself, the rule refers to a potential recession once the three-month moving average of the current unemployment rate exceeds by 0.5% or more the lowest three-month moving average of the past 12 months. According to Federal Reserve data, the current reading is 0.43%.
Even though the Sahm rule has flashed a warning signal, Sahm believes it may be due to special factors, namely an increase in immigration numbers adding extra supply to the U.S. labor market, artificially inflating the official unemployment rate.
She believes that this distortion effect on the data is significant enough to lead to incorrect conclusions. Sahm wrote, "Due to abnormal changes in labor supply caused by the COVID-19 pandemic and immigration, the Sahm rule is likely exaggerating the weakness in the labor market."
Furthermore, official revisions to past data always tend to downwardly adjust the initial readings. Additionally, typically when the U.S. Bureau of Labor Statistics releases nonfarm payroll data on the first Friday of each month, the market tends to focus on the establishment survey that counts nonfarm payroll jobs, rather than the household survey that calculates the unemployment rate.
This week, the Federal Open Market Committee (FOMC) of the Federal Reserve will hold a two-day meeting and a press conference early Thursday. Few economists expect the Fed to cut rates this month, but most anticipate it will prepare for a rate cut in September, marking the beginning of its first easing cycle in five years.
In June this year, policymakers revised their expected number of rate cuts for the year from three as forecasted in March to one, surprising Wall Street. The Fed's latest quarterly projections also anticipate slightly higher inflation levels than previously, as price pressures have proven to be more sticky.
The Fed has maintained a cautious stance, refraining from declaring victory over inflation for fear that premature easing could reignite inflation and jeopardize the Fed's credibility. Fed Chair Powell told investors in 2021 that inflation was transitory, but this prediction has proven to be significantly off the mark.
Sahm argued last week that the Fed should start cutting rates as the inflation rate has fallen enough to warrant a reduction from the current restrictive level of policy.
While the Sahm rule suggests that the Fed needs to remain cautious in the future, this alone is not enough to predict an imminent economic turnaround. The labor market distortions caused by immigration "amplify the growth in the unemployment rate," and the lingering aftershocks of the pandemic have injected too much noise into the data Sam summarized, "The economic recession is not imminent, but the risk of recession has increased."