The U.S. July employment data touched on the "Sahm Rule", which caused concerns on Wall Street. Claudia Sahm, the originator of the Sahm Rule and chief economist of New Century Advisors, personally wrote an article to express her views. The following are her views.
The U.S. is not in recession, even though the indicator that bears my name shows it is. The Sam Rule was triggered by last Friday’s weaker-than-expected jobs report, joining a long list of economic tools that have been unusually disrupted over the past four and a half years.
That being said—and I say this with a mixture of humility and concern—Sam’s rule still applies. The risk of a recession has increased, which strengthens the case for the Fed to cut interest rates.
The National Bureau of Economic Research (NBER) defines a recession as “a significant decline in economic activity that spreads throughout the economy and lasts for more than several months.” The NBER typically makes its official determination several months after evaluating a series of economic data. For now, most of the data considered by NBER still looks solid. For example, real consumer spending increased at an annualized rate of 2.6% in the second quarter, and employment increased by an average of 170,000 per month over the past three months. The one notable exception was employment in the household survey, which was essentially flat this year.
Even though the economy is slowing, it is still growing. At least there is no recession yet.
But conditions can change quickly, and by the time the NBER officially confirms a recession, it is usually too late to guide policymakers. The Sam rule is intended to be an early diagnostic tool. I created this rule in early 2019 to shorten the wait for an NBER determination and as part of an automatic trigger for fiscal policy during an economic downturn.
The rule, which later bore my name, was designed to be both simple and highly accurate: When the three-month moving average of the U.S. unemployment rate is 0.50 percentage points or more above its lowest value in the previous 12 months, the U.S. is in recession. The rule has correctly called every recession since 1970 and has not been triggered outside of a recession (although it came very close in 1976). Sam’s rule was triggered outside of a recession in 1959 and 1969, but a recession occurred within the following six months.
However, as any investment prospectus will tell you: past performance is no guarantee of future results.
Sam's rule relies on a powerful feedback loop: A relatively small rise in unemployment can turn into a large one. Workers who lose income weigh on consumer demand, causing more people to lose their jobs. Rising unemployment is often accompanied by lower wage growth, fewer jobs, and more overall uncertainty.
During U.S. recessions from 1947 to 2007-09, unemployment initially rose gradually and then increased sharply. On average, peak unemployment was nearly 3 percentage points above pre-recession levels. The increase in unemployment over the past year is in line with the range of prior recessions.
The level of unemployment isn’t decisive—it’s the change that matters. For example, unemployment was about 3.5% at the start of the 1969-70 recession and over 7% at the start of the 1981-82 recession. Over longer periods of time, demographic shifts affect the overall unemployment rate. The Congressional Budget Office estimates that the equilibrium unemployment rate peaked at over 6% in the late 1970s and slowly fell to 4% last year, in part because of an aging and more experienced workforce. Focusing on short-term changes, such as changes over a single year, makes recessions more comparable.
This brings us back to last Friday’s jobs report. The unemployment rate rose to 4.3% in July, bringing the Sam’s Rule to 0.53% – just above the trigger threshold. Even so, there are good reasons to think that the current rise in unemployment exaggerates recessionary dynamics.
Last fall, when unemployment began to rise, and this spring, when unemployment rose significantly in several states, I explained how things might be different this time—namely, why a triggering of Sam's Rule might not be the reason why the U.S. is in recession an indicator of. The increase in the labor force, especially the surge in immigration, has contributed significantly to the rise in unemployment.
In a recession, rising unemployment due to weakening labor demand gains momentum, which is why Sam's Rule has historically worked well. But rising unemployment due to an increase in the labor supply is different. Once jobs "catch up" to new job seekers, more workers are available to drive economic growth, and unemployment falls. Sam's Rule cannot distinguish between these two dynamics, and it looks even more severe when the labor force is expanding rapidly.
There are signs that stronger labor supply, not just weaker labor demand, helped push the Sam Rule above the 0.50% threshold. Unemployed people who were newly entering or returning to the labor force accounted for about half of the increase. This is a significantly higher share than in recent recessions, when most of the increase came from unemployed workers who were temporarily or permanently laid off. The current Sam Rule reading may overstate the extent of weakening demand and is not reaching recessionary levels.
Even so, risks remain. Recessions have occurred before when the labor force expanded, as in the 1970s, so the current situation is not an anomaly in the history of the early stages of a recession. Hiring is now back to where it was in 2014, when unemployment was 6%.
Fed Chairman Jerome Powell said last week that the data show that "labor market conditions continue to normalize gradually." However, the rise in unemployment over the past year, as reflected in my rule, now looks beyond normal levels and uncomfortably close to a recession. Now is the time for the Fed to use its tools and lower interest rates.
The article is forwarded from: Jinshi Data