Labor Market Report Could Trigger Significant Recession Indicator

The Sahm Rule, developed by economist Claudia Sahm, indicates that the U.S. economy has entered a recession when the three-month average of the national unemployment rate increases by 0.5% or more from its lowest point in the past twelve months. This rule has predicted recessions with 100% accuracy since the early 1970s. Should the jobs report on Friday for the month of July show an increase in the unemployment rate to 4.2%, the Sahm Rule would be triggered. However, economists, including Sahm herself, are cautious about viewing this outcome as an indicator of an impending recession in the U.S. economy given the current economic environment. "The rise in the unemployment rate is not as threatening as it would normally appear," Sahm wrote on July 26 in a post on Substack. Sahm argues that the current increase in unemployment does not account for recent changes in the labor market that were less common in previous instances when the Sahm Rule was triggered. These include pandemic-related distortions in labor force participation and a massive increase in immigration. "In past recessions, the share of new entrants — those without a work history or returning to the labor force — decreased," Sahm wrote. "The weakening of the labor market discourages them from seeking work. Currently, the share of new entrants remains unchanged. This suggests that an increased labor supply due to immigrants is raising unemployment and is not a sign of weaker demand, as would typically be seen in a recession." Michael Gapen, Head of U.S. Economics at Bank of America Securities, recently told Yahoo Finance that the Sahm Rule cannot be seen as a useful recession tool in the current economic situation. "The unemployment rate is mostly rising because labor force growth through immigration is outpacing labor demand," Gapen said. For now, said Gapen, the recent increase in unemployment is not a story of companies cutting costs through layoffs. Asked at a press conference on Wednesday whether he was concerned about the Sahm Rule being triggered, Federal Reserve Chairman Jerome Powell said: "The real question is whether we are worried about a sharper downturn in the labor market. The answer is that we are paying close attention." He characterized the rule as a "statistical regularity" and added, "It's not like an economic rule that tells you something has to happen.