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What is the Sahm rule and why it matters

June 25, 2024 at 05:43PM
Federal Reserve Governor Lisa Cook spoke today and highlighted that unemployment is at a low level.

Objectively, it’s true:

But I want to highlight the extreme right-hand side of the chart because of the Sahm rule. it’s named after economist Claudia Sahm and is an economic indicator aiming to identify a recession sooner. The rule states that a recession is likely underway if the three-month moving average of the national unemployment rate rises by at least 0.5 percentage points above its lowest point in the previous 12 months.

The lowest point in the last 12-months is July 2023 at 3.5% and it’s currently at 4.0% (though the three-month average is still at 3.9%).

Historically, this is the tipping point for when job losses accelerate, as shown in this BofA chart:

The Sahm Rule successfully signaled the beginning of every U.S. recession since the 1970s in a timely manner. For example, it accurately flagged the recessions starting in 1974, 1980, 1981, 1990, 2001, and 2007-2009.

In Europe and Canada, researchers have looked at the Sahm Rule and found that it needs to be adjusted and that argues that it’s more of a guide than a law. Both the UK and Canada have already violated it, so if it’s coming in the US, it’s coming sooner there.

What I think is important here is the principle: once there is a material rise (0.5-0.7 pp) in the unemployment rate (ignoring noise), there is a snowball effect. I’d argue that effect is particularly large when policymakers are unresponsive and unlikely to cut rates fast enough.

This article was written by Adam Button at www.forexlive.com.

What is the Sahm rule and why it matters