Friday’s Jobs Report Could Trigger a Usually Reliable Recession Indicator

Update, Aug. 1, 2024: This article has been updated to include Federal Reserve Chair Jerome Powell’s remarks.

Key Takeaways

• If Friday’s labor market report shows the unemployment rate ticked up in July, it could trigger the Sahm Rule’s recession indicator.
• The Sahm Rule theorizes that we are likely in a recession if the three-month moving average of the unemployment rate rises half a percentage point from its low point in the previous 12 months.
• However, other recession indicators have been flashing since 2022 and there has not yet been a downturn.

This week’s official report on jobs could set off a key warning sign that’s predicted every recession since 1970.

The indicator to watch in the Bureau of Labor Statistics payroll report for July due Friday is the unemployment rate: if it rises to 4.2% from its June level of 4.1%, it would set off a recession alarm called the Sahm Rule. The rule is a simple one by the standards of economics: If the three-month moving average of the unemployment rate rises half a percentage point from its low point in the previous 12 months, then the economy is in a downturn.

The rule is named after its inventor, economist Claudia Sahm, who in 2019 proposed it as a way for the government to know when a recession was coming so it could automatically send out stimulus checks to help families weather the storm.

Lawmakers never created automatic stimulus checks, but economists love the indicator for its simplicity and reliability. When the Sahm rule was applied to historical employment data, it correctly identified a looming recession in every instance over the past half century.

Economists surveyed by the Wall Street Journal and Dow Jones Newswires expect unemployment levels will narrowly avoid triggering the Sahm rule and remain at 4.1%. However, the labor market has surprised in recent reports.

The unemployment rate has steadily ticked up in recent months to the point where the Sahm Rule is on the verge of being triggered. A 4.2% unemployment rate in July would mean that the three-month moving average has risen half a percentage point since last August. 

In the past, such rises in unemployment have meant that the economy is already in the midst of a downturn. (Recessions are only officially declared by the National Bureau of Economic Research, the nation’s official recession referees, months or even years after they began, based on backward-looking data.) 

Other Signals (So Far Falsely) Predicted Recession

For years, some economists have forecast an imminent recession because of the Federal Reserve’s campaign of interest rate hikes, which are intended to slow the economy in order to contain inflation. Historically, high interest rates make borrowing and spending so costly for businesses and individuals that the economy nosedives sooner or later.

This time around, economists have found reasons to doubt the rule will hold true. The country is in an unusual economic situation, and other previously reliable recession indicators have set off false alarms.

An indicator called the inverted yield curve has warned of a recession since mid-2022, but that has yet to materialize. An index of leading economic indicators compiled by the Conference Board, also signaled in early 2022 that the U.S. was on the brink of a recession but has since switched off. 

When asked about the Sahm rule, Federal Reserve Chair Jerome Powell said Thursday that there is reason to believe the economy will act differently this time around.

“Never assume it’s going to be just the same,” he said in a press conference following the central bank’s policy meeting. “Let’s remember that this pandemic era has been one in which so many you know, apparent rules have been flouted.”

“The situation really is unusual or unique in that so much of this inflation came from the shutdown of the economy and the resulting supply problems in the face of, admittedly, very strong demand.”

Labor Market Isn’t As Dire As It Seems—Yet

Further complicating the picture, the unemployment rate hasn’t risen just because people are getting laid off, but because more people are entering the workforce and are looking for work they haven’t found yet—hardly reason for alarm. And unemployment is still near its pre-pandemic average after hitting a 50-year low last year amid high demand for workers.

“If the recent rise in the unemployment rate proves to be more a matter of normalization from its exceptionally low level generated by the unique circumstances of the post-pandemic economy, rather than the early signs of a downturn, it would not be the first recession signal to misfire this cycle,” Sarah House and Aubrey George, economists at Wells Fargo Securities, wrote in a commentary.

Still, the rule being invoked could prove to be a significant turning point in an economy that has, up to this point, defied many predictions of a slowdown.

“With momentum in the jobs market difficult to shift, we see the risk of a recession remaining unusually high at the moment,” House and George wrote.

Read the original article on Investopedia.