A disappointing jobs report released on Friday morning led to a significant drop in the stock market and increased concerns about an impending recession, all due to what is known as the “Sahm Rule.”
So, what exactly is the Sahm Rule?
Named after economist Claudia Sahm, who previously served as a top economic advisor during the Obama administration, it identifies a key indicator of upcoming recessions. According to Sahm, since 1970, whenever the three-month moving average of the U.S. unemployment rate is more than half a percentage point higher than the lowest three-month moving average from the previous year, a recession has followed shortly after.
While it may sound complex, the recent jobs report provides a practical example. The unemployment rate in July rose to 4.3 percent, with the average rate over the past three months being 4.13 percent. This is significantly higher than the lowest three-month average from the previous year, which was 3.63 percent between June and August 2023.
As a result, the Sahm Rule has been triggered.
However, the rule is not just a warning but also a set of recommendations. In a 2019 paper where Sahm introduced this early warning system for recessions, she suggested that governments should start distributing stimulus payments immediately upon the activation of this alert. This proactive approach aims to expedite the response to a recession by avoiding delays caused by debates on the likelihood of a recession and appropriate measures to address it.
Despite the importance of this approach, it has not been widely adopted by the political system due to existing financial constraints. With the federal government already facing a $35 trillion debt and projected to run a $2 trillion deficit this year, there is limited room for additional stimulus measures.
Nevertheless, the markets have taken the Sahm Rule seriously, evident from the significant sell-off in the stock market and the decline in bond yields following the release of the jobs report. Investors seem to be anticipating the economic impact of an impending downturn.
However, there is a potential caveat to consider. Sahm herself has indicated that this alarm may be premature. She believes that recent changes in labor supply, including a surge in immigration post-pandemic, may have distorted the applicability of the Sahm Rule in assessing the job market’s strength.
It is crucial to exercise caution when relying on historical trends for economic predictions, as Sahm and Federal Reserve Chairman Jerome Powell have highlighted. While these indicators offer valuable insights, they do not guarantee future outcomes.
Ultimately, the possibility of a recession remains uncertain until official data confirms its occurrence. The National Bureau of Economic Research serves as the authoritative body for declaring recessions, considering various economic indicators in their assessment.
Following the recent jobs report, the outlook has darkened, raising concerns about the government’s and Federal Reserve’s ability to respond effectively given prevailing fiscal challenges. The Sahm Rule’s track record in predicting recessions underscores the importance of monitoring economic trends closely.
As we navigate through these uncertain times, let’s hope that the Sahm Rule proves to be inaccurate this time around.
