The Sahm Rule and Other Indicators: Revisited — Evening Brief – 08.02.24 

In our July 16 Evening Brief, The Sahm Rule and Other Indicators, we discussed the recently widely mentioned Sahm Rule, as well as various other indicators and their signals of a possible pending recession. Following the release of the July nonfarm payrolls today there is still room for discussion. Payrolls increased by 114,000, well short of estimates of 175,000, and the unemployment rate rose to 4.3% from 4.1%. 

With employment growth underperforming, wages have cooled more than expected. Average hourly earnings rose only 0.2% in July, compared to 0.3% projected and 0.3% in June. On an annual basis, the 3.6% growth rate missed estimates of 3.7% and fell from a downwardly revised 3.8%.   

The economy has thus far contradicted predictions of a recession. The increase in monetary stimulus over the past few years, along with a significant rise in deficit spending, had a crucial role in bolstering economic growth. Nevertheless, the increase in spending has reached its apex, which is negatively impacting future growth. As monetary stimulus is withdrawn, the likelihood of a recession rises due to a decrease in consumption. As a result, the Sahm Rule and employment data are highly significant indicators of a recession. 

“The reality is that the full-time employment rate is falling sharply. Historically, when the rate of change in full-time employment dropped below zero, the economy entered a recession,” wrote Lance Roberts, Chief Investment Strategist at RIA Advisors. The rate of change is currently below zero. 

The issue with a decline in full-time employment is that it has a detrimental effect on economic consumption. Although we have managed to counterbalance the decrease with a substantial rise in deficit spending, the latter is not viable in the long term. 

Although there is currently no clear sign of an impending recession within the next year, it is advisable to closely monitor employment trends as around 70% of economic expansion is driven by consumer spending. “The “Sahm Rule” is another essential indicator suggesting that underlying economic weakness is more significant than the headlines suggest,” said Roberts. 

The Sahm Rule, together with the Leading Economic Indicator readings and the still-inverted yield curve, suggests that conditions for a recession exist. This is most likely why the Federal Reserve is moving toward cutting interest rates, despite inflation being considerably above target. 

Meanwhile, not only is a September rate cut likely but even a 50-basis point cut is now a possibility. “Taken together with the higher jobless claims, contraction in the manufacturing hiring survey and July’s jobs report, it is likely that the Fed will start cutting interest rates next month and there is expectation that it may need to cut more aggressively than previously penciled in,” said RBC analyst Janet Mui. 

Interest-rate swaps show that traders expect a more than 70% possibility of a half-point move in September, with a total of around 115 basis points of cuts by the end of the year.