Unemployment Rate Spike Triggers ‘Sahm Rule’ Indicator, Signaling Potential US Recession

Traders work on the floor of the New York Stock Exchange (NYSE) during morning trading in New York City, on Jan. 11, 2024. Angela Weiss/AFP via Getty Images

An economic indicator that has historically predicted U.S. recessions with high accuracy is now signaling a potential recession for the country following the recent spike in unemployment numbers.

The U.S. Bureau of Labor Statistics (BLS) released the unemployment rate data on Friday, bumping it up to 4.3 percent for July, up from 4.1 percent the previous month. Subsequently, the Sahm Rule indicator, which uses unemployment data, was updated. When the indicator rises 0.5 percent or more, it signals a recession.

The indicator registered a value of 0.53 for July.

Claudia Sahm, the inventor of the Sahm Rule, said in a July 26 blog post that the indicator has given only two false signals since 1959. At all other times, the indicator has been accurate.

However, Sahm cautioned against viewing the current recession signal as a fully valid one, pointing out that the labor market has seen “unusual shifts” which could have distorted the indicator’s accuracy.

Sahm said that large variations in the labor force, combined with an increase in immigration in recent years, could have affected the unemployment rate in a unique way, atypical of prior business cycles.

However, this doesn’t mean that the Sahm Rule warning is to be ignored, she says. A recession may not be imminent, but “the risks of a recession have risen.”

The number of unemployed individuals rose by 352,000 in July. This took the total number of jobless people to 7.2 million for the month, more than a million higher than a year ago.

Amid dismal employment numbers and the Sahm Rule signaling a recession, U.S. stock markets crashed on Friday. The S&P 500 plunged by over 100 points, declining by 1.84 percent while the Dow Jones index crashed by more than 600 points.

Asian markets followed suit on Monday, with Japan’s Nikkei index tumbling by over 12 percent as of 07:25 a.m. EDT. This was the biggest single-day sell-off for the index since the 1987 Black Monday crash.

The Shanghai index was down by nearly two percent by this time while India’s Nifty 50 declined 2.68 percent.

Interest Rate Situation

The U.S. Federal Reserve has kept interest rates unchanged at a range of 5.25 percent to 5.5 percent since July last year. Investors expected rate cuts to kick off earlier this year, but that didn’t happen.

Keeping the rates as is for longer means companies have to continue paying higher interest for loans, creating financial difficulties for businesses. Higher interest rates can also discourage people from taking on debts or buying goods on credit. Both these factors contribute to dampening the economy, including weak performance in the stock market.

Interest rate traders now see a very high chance of the Fed cutting down rates by 50 points in the September meeting, according to data from the CME FedWatch tool.

Fed Chair Jerome Powell discussed the Sahm Rule during a press conference last week, pointing out that the indicator is a “statistical thing” and not an “economic rule.”

He claimed the labor market was “normalizing.” The bank is “watching carefully to see if it turns out to be more, it starts to show signs that it’s more than that, then we’re well-positioned to respond.”

As for bringing down interest rates, Powell said the Fed officials “do not expect it will be appropriate to reduce the target range for the federal funds rate until we have gained greater confidence that inflation is moving sustainably toward two percent.”

Inflation has remained at or above three percent since June last year, above the Fed’s target rate.