Meeting the Sahm rule recession threshold supports a September Fed rate cut
The US unemployment rate has edged above most estimates of the NAIRU for the first time since 2021, supporting a Fed rate cut next month.
The US labour market was weaker than both the Fed and the market expected in July. Payroll employment rose by less than expected, up another 0.1% for the fourth month in a row, such that annualised trend growth of about 1% is now a touch below pre-COVID levels, while the unemployment rate rose from 4.1% in June to 4.3% in July.
The outcomes support a Fed rate cut in September. There is some risk of a larger initial cut if the labour market rapidly deteriorates, where history shows rising unemployment often quickly accelerates.
After all, the unemployment rate has risen from a recent multi-decade low of 3.4% and is now marginally above Fed and economist estimates of the NAIRU for the first time since the economy was recovering from the worst of COVID, where the FOMC had forecast that unemployment would peak at 4.2% at the end of next year.
The increase in the unemployment rate has also seen it satisfy the Sahm rule’s threshold, which is that an increase of 0.5pp or more in the average unemployment rate from the low point of the preceding twelve months has coincided with every modern recession.
The Sahm rule is not perfect and it may not continue to provide a reliable signal, but it is the best coincident indicator of recession, leveraging off the fact that US recessions have all involved a sharp rise in unemployment driven by job losses.
To date, surveyed employment has been flat in trend terms since late last year and has fallen in some months, opening up a very large gap with the number of payroll jobs, which are sourced from separate survey of businesses.
Adjusting employment using payroll concepts – for example, adjusting for people who work more than one job – does not explain this gap, where adjusted employment has fallen in six of the past twelve months.
It seems likely that the gap between employment and payroll jobs will be at least partly closed by revisions to the data.
The level of employment should eventually be revised up when its population benchmarks capture the recent surge in migration into the US, while payrolls should be revised lower this month when its survey benchmarks are revised to better reflect the closure of businesses as the economy has slowed.
However, recent weak growth in employment may not be revised much because the ratio of employment to the working-age population should be less affected by eventual migration-driven revisions to population benchmarks and this ratio has recently declined from 60.4% to 60.0%.
As for job losses, unemployed workers who lost their job have increased from 1.6% of the labour force last year to 2.1%, which is just over half the 0.9pp increase in the (rounded) unemployment rate from its latest low point. Most of these workers report that they have either permanently lost their job or completed a temporary job, although some of them have said that they have been temporarily laid off, probably partly influenced by worse weather than usual.
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Based in Sydney, Kieran Davies is Chief Macro Strategist at Coolabah Capital Investments, an asset manager with 40 executives and over $8 billion in fixed-income strategies. Kieran is responsible for macroeconomic research and investment strategy, contributing to the investment decisions of the firm. Kieran has long experience as a macroeconomist in both the private and public sectors. He has worked most recently as Chief Markets Economist for National Australia Bank and was previously Chief Economist, Australia and New Zealand, for Barclays Bank and ABN Amro Bank/RBS. Kieran also worked as Principal Adviser on the macroeconomy and budget policy in the Commonwealth Treasury and Director of Forecasting.
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Based in Sydney, Kieran Davies is Chief Macro Strategist at Coolabah Capital Investments, an asset manager with 40 executives and over $8 billion in fixed-income strategies. Kieran is responsible for macroeconomic research and investment strategy,...
Based in Sydney, Kieran Davies is Chief Macro Strategist at Coolabah Capital Investments, an asset manager with 40 executives and over $8 billion in fixed-income strategies. Kieran is responsible for macroeconomic research and investment strategy,...
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