Labor Market and Recession Signals: Complexity of Indicators

The Chairman of the US Federal Reserve, Jerome Powell, recently discussed the so-called "Sahm Indicator," which historically signals recessions when the three-month moving average of the unemployment rate is 0.5 percentage points or more above its 12-month low. However, Powell emphasized that this is a statistical regularity rather than a natural law. Claudia Sahm, the economist after whom the indicator is named, concurs and describes these indicators as empirical regularities of past economic data. Despite the rise in the unemployment rate to 4.3% in July, which triggered the Sahm Indicator, pandemic-related distortions might exaggerate the signal. Sahm argues that unusual changes in labor supply, caused by the pandemic and immigration, could overstate the weakness of the labor market. Generally, it is advisable not to rely solely on a single signal, similar to the case with the yield curve signal and the Conference Board's Leading Economic Index. The economy is complex and numerous factors play a role. For instance, the current economic situation shows unusually high job openings, indicating strong demand. At a peak in March 2022, there were two open positions per unemployed person. This demand curve has so far challenged the traditional theory that falling job openings coincide with rising unemployment and decreasing inflation, explained by the Beveridge curve and the Phillips curve. However, this does not mean that these theories are useless. This week's labor market data reveal a slowdown in job growth and an increase in the unemployment rate to a three-year high. At the same time, there is a decline in unemployment claims, wage growth, and worker confidence. These developments increase the pressure on the Federal Reserve to ease monetary policy to avoid a recession. Despite recent signs of a slowing economy, a recession remains a normal and not unlikely condition. This week, Sam Stovall of CFRA raised the 12-month target for the S&P 500 to 6,145, indicating a potential value increase of nearly 14%. Recent data also show a stabilizing housing market and an improvement in consumer spending, even as consumer confidence wanes. Mortgage rates slightly decreased and house prices continued to rise. In summary, economic indicators are moving towards a balanced state, although the risks for inflation and employment still need to be scrutinized. The next Federal Reserve meeting is scheduled for September 17-18, where an interest rate adjustment may be discussed.