This Important Recession Indicator Says We’re Not There Yet

This Important Recession Indicator Says We’re Not There Yet
Paul Allison, CFA

24 days ago2 mins

It’s never been easy for the US Federal Reserve (the Fed) to bring down inflation. Its biggest trustiest tool – interest rate hikes – can get the job done, but it tends to plunge the economy into a recession as it reins in price gains. So that’s what everyone’s on the lookout for now. Signs that the US is falling into a recession, or signs that, this time around, it actually might sidestep that seemingly inevitable pitfall.

And that’s where this chart comes in. It’s a really important indicator, watched closely by the honchos at the Fed, and it essentially tracks employment. It shows the difference between the current three-month average unemployment rate and the lowest three-month average unemployment rate from the past 12 months. Think of it as the trajectory of unemployment: the faster it rises, the wider the gap becomes, and the more the Sahm climbs.

The Sahm rule was devised by former Fed economist Claudia Sahm, who observed that when the gap hits 0.5 percentage points, the probability of a recession jumps to more than 50%. Right now, the average three-month unemployment rate is 3.83%, and the lowest three-month rate over the last 12 months is 3.5%. That puts the Sahm rule at 0.33% – meaning there’s a 40% chance of a recession.

If you’re in the doomsayers’ camp, you have every right to point out that a 40% probability is pretty high, and that the direction of travel has been toward that 0.5% number. Fair enough. But unemployment has been creeping higher only recently, mostly since its big jump in August, and I’d bet there’s a decent chance it edges only slowly from this point, especially given the next few months are traditionally when companies add workers.

Look, the US economy is probably pretty close to a recession, I can’t deny that. Interest rate hikes exact a heavy toll on an economy, after all. But at the end of the day, the Sahm rule says that it isn’t in recession yet. And if that rule can hold, we might just avoid one, at least for now.



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