Debates | Economics & Growth | Monetary Policy & Inflation | Rates | US
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Summary
- Unemployment has been increasing for the past 1.5 years, triggering Sahm’s rule.
- But Sahm’s rule is more a statistical regularity than a predictive model of recession.
- With other labour market indicators and aggregate demand data pointing at expansion, the US economy is not headed for recession.
Market Implications
- We are short 10Y and 30Y US Treasuries.
- Risk exists that the Fed may be unable to implement its planned 2025 cuts, though such a determination is unlikely before the elections.
The Big Question
Unemployment has increased for 1.5 years and triggered Sahm’s rule (Chart 1). Will the increase continue and the economy enter recession?
The Case for 7% Unemployment
Sahm’s rule has used unemployment to identify every recession since the 1970s. This time, it was triggered in July (Chart 1). Unemployment is approaching 7%, the highs of the 1990-91 and 2001 recessions.
Labor market indicators all point towards weakening. The KC Fed labour market indicator, which aggregates 24 labour market indicators, is now well below its 2019 level (Chart 2). In addition, the Quarterly Census of Employment and Wages points at large negative annual revisions to NFPs next February.
Broader macro indicators also suggest growth is about to slow. The Fed’s own Financial Conditions Indices show financial conditions are detracting from growth (Chart 3). Rising credit card delinquencies point at overstretched consumers. Manufacturing PMIs have been below 50 for the past two years.
The Case for 4.5% unemployment
Even if unemployment is headed higher, it is likely to stabilize at a level consistent with expansion, for instance 4.5%.
The labour market is not slowing but normalizing from an exceptionally strong recovery (Chart 2). The recent increase in unemployment reflects an increase in labour supply, mainly unskilled immigration, rather than a decrease in labour demand. The QCEW data is understating employment growth because it is based on unemployment insurance data that misses out the past two years’ surge in undocumented migrants. In net, firms are still hiring and jobless claims remain low (Charts 4 and 5). Sahm herself says that her rule is giving a false positive this time.
Growth is above trend. The Atlanta Fed Q3 GDP nowcast is 3.2%, following growth of 2.4% annualised in H1 (Chart 6). And risks are more on the upside than downside. The Fed is easing policy, and fiscal consolidation is unlikely until well into next year, if at all.
Market Consequences
With supportive monetary and fiscal policy, the data is likely to continue to show unemployment stabilizing around current levels and strong growth momentum. Inflation is likely to prove stickier than the Fed expects. As a result, the Fed may be unable to implement its planned 2025 cuts, though such a determination is unlikely before the elections.
Meanwhile, strong growth dynamics leave us short 10Y and 30Yy USTs.
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(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)