A closely tracked recession indicator, the Sahm rule, has now been triggered. Here’s what that means.

But the data that is used to make recession calls suggest the economy is still expanding

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A recession indicator widely followed on Wall Street was just triggered by the July jobs report.

But the person who created it doesn’t think the U.S. economy actually is in recession right now. And Federal Reserve Chair Jerome Powell said the indicator doesn’t carry any particular significance.

So, first, the data: with the unemployment rate reaching 4.3% in July, the three-month moving average of the unemployment rate is at least 0.5 percentage points above the minimum of the three-month averages from the previous 12 months. The Sahm rule states that reaching the 0.5% level means there’s a recession.

Unpacking that, what the rule is basically saying is when the jobless rate is rising pretty quickly, the economy is slumping.  The three-month average is important because it smooths out times where there’s a quirk that only impacts the unemployment rate for a month.

The rule, named after former Fed economist Claudia Sahm, is closely tracked because it’s worked in the past.

This chart, from Bank of America, shows previous readings and its historical accuracy. Most of the time when the unemployment rate rises by 0.5 percentage points, the recession already started. (The 1960 recession was an exception, but the downturn did start five months later.)

What about now?

Sahm herself told the Wall Street Journal that she actually doesn’t think the economy is in recession. Changes in the labor supply after the pandemic and the recent jump in immigration has diminished its usefulness, she says.

That said, she is worried about the direction of the U.S. economy, and Sahm had said ahead of Wednesday’s Fed decision that the central bank should cut interest rates.

Data that has come out over the two days after the Fed meeting suggests the central bank should have listened — as evidenced not just by the rise in the unemployment rate but also by other indicators such as fall in the ISM manufacturing activity index and the rise in first-time jobless benefit claims. 

Bond yields BX:TMUBMUSD10Yhave dropped precipitously, while stocks SPX have slumped.

Powell, the Fed chair, was asked about the possibility of the Sahm rule being triggered on Wednesday.

“I would just say the question really is one of, are we worried about a sharper downturn in the labor market,” said Powell. “And the answer is we’re watching really carefully for that.”

He said the Sahm rule was “a statistical regularity, it’s not like a economic rule where it’s telling you something must happen.” 

Powell added it looks like a “normalizing” labor market.

Officially, by the Fed’s own definition, the labor market is now on the wrong side of normal. The Fed’s long-run unemployment rate forecast is 4.2%, and now the jobless rate is a tenth of a percentage point above that.

That doesn’t mean that’s the U.S. economy is in recession, however. The National Bureau of Economic Research defines a recession as a significant decline in economic activity that is spread across the economy and lasts more than a few months.

There is no hard-and-fast rule determining what is and what is not a recession — the NBER has a committee of economists that decide. 

But the organization puts particular emphasis on a few indicators, including nonfarm payrolls employment, personal income adjusted for inflation excluding transfers, consumer spending adjusted for inflation and industrial production.

None of them have turned negative when measured against year-ago levels.

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