Dom’s Quick Take: New Indicator Highlights Recession Risks

Summary

• The Richmond Fed has devised a recession indicator based on jobless claims that is more accurate and timelier than Sahm’s rule.
• Should continuing claims continue increasing at the pace of the past four weeks, the indicator would signal recession at end-October 2025.
• By contrast with 2008, this time a continued increase in claims would likely see the US dollar weakening as it is losing its safe haven status and a recession this time would be mild compared with the GFC.

Market Implications

• I still expect two-three cuts in 2025 starting at the September FOMC against markets pricing 1.8.

Jobless-Claims-Based Recession Indicator

Continuing jobless claims broke into a new range last week (Chart 1). Here, I discuss how a continued uptrend could signal a recession by end-year.

The Richmond Fed has used jobless claims to build a recession signal, the SOS indicator. Like Sahm’s recession indicator, the SOS indicator shows that unemployment initially rises slowly and then fast in a recession (Chart 2). By contrast with Sahm’s, which is based on total unemployment, the SOS indicator is based on insured unemployment (i.e., ratio of continuing claims to the number of covered workers (Chart 3).

Compared with Sahm’s, the SOS indicator has several advantages. First and foremost, because it relies on unemployment claims, it sidesteps the data quality issues of the unemployment rate on which Sahm’s rule is based. In May, the household survey showed unchanged unemployment based on a 696k contraction in employment and on a 625k contraction in the labour force. Neither is plausible. Household survey (HH) data has been questionable since the surge in undocumented immigration in 2022. An unstable ratio of HH survey to payroll survey employment shows this (Chart 4).

Also, unlike Sahm’s rule, the SOS indicator has had no false positive over the past 50 years. On average the SOS indicator has identified recessions with a 2.4-month lag against Sahm’s 3.4 months. The SOS indicator is also based on higher frequency data (weekly) compared with monthly for Sahm’s rule.

Chart 1: Continuing Claims Rise	Chart 2: Recessions Mean Fast UR Increases
Chart 3: Insured Subset of Total Unemployed	Chart 4: HH Survey Data Unreliable

Recession by End-2025?

The value of the SOS indicator is currently 0.015. A value above 0.2 signals a recession.

Continuing claims have increased by an average of about 20k over the past month. Should this pace persist, the SOS indicator would hit the recession threshold of 0.2 in late October. By contrast, an increase of 10K would see the threshold hit in early January and a 50k increase in early September (Chart 5).

By comparison, during the 2007- 09 recession, the SOS indicator went from 0.015 in August 2007 to above 0.2 in April 2008, four months after the start of the recession.

The SOS indicator, like Sahm’s, must be placed in context. Sahm’s indicator hit the recession signalling threshold of 0.5 in July 2024. At the time I argued this was a false positive that reflected labour market normalisation following the pandemic labour shortages. My conviction was based on strong coincident indicators of growth.

Similarly, in Q4 2023, the SOS indicator rose to 0.2 but did not cross that level and trigger the recession signal. The macroeconomic context at the time (e.g., Atlanta Fed GDP nowcast, personal consumption and income) imports were strong and would have shown that the indicator was more likely to decrease than rise.

This time the SOS indicator will be especially helpful on figuring out whether the ongoing slowdown is more likely to be a recession or instead to be a self-correcting weakness. Based on current data, I assign equal probability to each outcome.

Chart 5: Recession by End-Year?	Chart 6: SOS vs. Sahm

Market Consequences

I expect USD weakness to accompany a rise in the SOS indicator, by contrast with 2008 when USD strength accompanied a rising SOS indicator, for two reasons (Charts 7 and 8).

First, this time a recession would be of median intensity, much less severe than the GFC that was a systemic financial crisis. Second, USD appreciation in 2008 reflected the role of the dollar as a safe haven and recent price action suggests the role is weakening (Charts 9 and 10).

This analysis does not change my expectation of two-three Fed cuts in 2025, which is based on equal risks of recession and self-correcting weakness. However, changes in the SOS indicator will help me figure out which is more likely and change my Fed call accordingly. Markets currently price 1.8 2025 cuts.

Chart 7: Higher Claims, Weaker Dollar in 2025	Chart 8: Higher Claims, Stronger Dollar in 2008
Chart 9: Higher VIX, Lower Dollar?	Chart 10: Higher VIX, Higher Yields?

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