The Sahm Rule and Other Indicators — Evening Brief – 07.16.24
According to some economists, a recession is unavoidable (of course, it’s part of the business cycle), while others argue that the economy is still growing, albeit sluggishly, and that an “official” NBER-defined recession will probably start in the next few months – although, as usual, we won’t know for certain until nearly a year later.
Even after reviewing a wide range of economic and financial statistics, there is still room for discussion. While U.S. macroeconomic risk is increasing, the economy has not yet hit a critical threshold.
We’ll begin with a metric that has been generating fiery debate in recent days about an impending economic downturn: the Sahm rule, named after economist Claudia Sahm. The signal for recession occurs when the indicator increases by 0.50 percentage points or more. This is determined by comparing a three-month average to the lowest of the three-month averages from the previous 12 months. The current reading for June is 0.43, indicating that an official recession warning may be issued in the upcoming report later this month.
The Sahm indicator has a robust historical performance, and so its cautionary signal should not be disregarded. However, depending on a single indicator (based just on unemployment data in this situation) is inherently risky because no metric or model is perfect.
At the same time, not very long ago, economists lauded the nearly perfect historical performance of the U.S. Treasury yield curve as a dependable indicator of economic downturns. An inverted curve has consistently been linked to economic downturns, foreshadowing each recession since the late 1960s. In the earlier part of the year, it stayed inverted for over 527 days, surpassing the previous record established in 1980.
Yield curve inversion is not limited to the U.S. The Canadian yield curve has also inverted, with persistent inflationary pressures lingering despite the central bank’s recent decision to trim its benchmark rate. The U.K. yield curve has only recently flattened after being inverted for more than a year.
The inversion of the U.S. yield curve has not been this pronounced since the Great Depression. Historically, recessions have always followed this pattern. However, experts argue that this time is unique because it does not indicate a contraction in credit as it has in previous instances. Additionally, stock markets have witnessed a powerful rally throughout the inversion. Moreover, the U.S. economy has continued to chug along for over a year and a half since the curve inverted.
A look at some U.S. business cycle indicators reveals a decent performance in terms of output. Both the Philadelphia Fed’s ADS Index and the Dallas Fed’s Weekly Economic Index are currently showing signs of economic growth. These indicators suggest the probability of a recession is still low.
The risk of recession is always present, and it may be slightly higher now than it was 6 to 9 months ago, but it is still premature to conclude that a downturn has begun. Conditions may deteriorate in the weeks and months ahead, but for the time being, moderate growth appears to be the clear favorite.