Former Federal Reserve economist Claudia Sahm cited the job market indicator that bears her name as she warned investors not to call an imminent U.S. recession too soon.
The founder of Sahm Consulting acknowledged in a post on Substack that the risk of a recession is certainly rising as labor demand weakens, but she believes that is largely due to the lagged effects of an overheated economy, with an exodus of workers known as the "Great Resignation" leaving companies starved for talent.
While an increase in the number of workers actively seeking work but unable to find it is a necessary precursor to a contraction in the U.S. economy, Sam noted that other indicators are inconsistent with broad weakness in economic activity, including consumer spending and another key labor market data: nonfarm payrolls.
“While Sam’s Rule is about to be triggered, a recession is not imminent,” she wrote on Friday.
The rule, named after Sam, states that a recession is likely to begin once the current three-month moving average of the unemployment rate exceeds the lowest three-month moving average over the past 12 months by 0.5% or more. The current reading is 0.43%, according to the Fed.
Even if the Sam rule is flashing a red light, Sam believes that it may be due to special factors, namely that the increase in the number of immigrants has created additional supply to the US labor market, artificially raising the official unemployment rate.
She argues that this effect distorts the data enough to lead to incorrect conclusions. “The Sam rule is likely to overstate labor market slack because of unusual changes in the labor supply caused by the COVID-19 pandemic and immigration,” Sam wrote.
Moreover, official revisions to past data always revise the initial reading downward after the fact. And, typically, when the Bureau of Labor Statistics releases nonfarm payrolls on the first Friday of each month, the market tends to focus on the establishment survey that counts nonfarm payrolls rather than the household survey that counts the unemployment rate.
This week, the Federal Open Market Committee (FOMC), the Fed's policymaking body, will hold a two-day meeting and hold a press conference in the early hours of Thursday. Few economists expect the Fed to cut interest rates this month, but most expect it to prepare for a September rate cut, which would mark the start of its first easing cycle in five years.
Policymakers surprised Wall Street in June by revising their expected number of rate cuts this year to just one, from three predicted in March. The Fed’s latest quarterly projections also project slightly higher inflation than previously expected as price pressures prove stickier.
The Fed has taken a cautious stance, refusing to declare victory over inflation for fear that premature easing would reignite inflation and jeopardize the Fed's credibility. Fed Chairman Jerome Powell told investors in 2021 that inflation was only temporary, a prediction that turned out to be wildly wrong.
Sam argued last week that the Fed should start cutting interest rates now that inflation has fallen enough to justify lowering policy from its current restrictive level.
While Sam’s Rule suggests the Fed needs to remain cautious going forward, it is not enough to predict an imminent reversal of the economy. Labor market distortions caused by immigration “amplified the increase in unemployment,” and the persistent aftershocks of the pandemic have injected too much noise into the data.
“A recession is not imminent, but the risk of a recession has increased,” Sam concluded.
Article forwarded from: Jinshi Data
