Job market near major recession warning

One of the best indicators of short-term recession is the job market. The release of the October jobs report showed that unemployment had reached 3.9%. Small increases in the unemployment rate have always been enough to trigger a recession. This is called the Sahm rule. We’re not talking about a recession yet, but it could get closer if the unemployment rate doesn’t improve from now on.

Why it has worked historically

The Sahm rule is designed to quickly determine whether the U.S. economy is in recession, so that policymakers can respond. It was designed by economist Claudia Sahm.

Using employment data is useful because it is released weeks before most other economic indicators. This approach is interesting because unemployment has a significant impact on economic growth. Consumer spending makes up about two-thirds of the economy. So, when jobs are lost, it is a safe bet that consumer spending decreases and, therefore, economic activity also weakens, because consumer spending is the largest component.

Build the metric

The measure looks at the current 3-month average unemployment rate compared to the low unemployment rate over the previous 12 months. The lowest 12-month unemployment rate is currently 3.4%, as happened twice in January and April 2023. Next, the recent unemployment figures for the last 3 months (August, September and October) are respectively 3.8%, 3.8% and 3.9%. Therefore, if unemployment remains at or above the current level of 3.9% in the November and December jobs report, or if it simply increases noticeably in November, then the indicator will speak of a recession. A recession could be suggested by this indicator with the next employment report on December 8.

The balance sheet

The indicator has regularly reported recessions since the 1960s, but has also recorded some false positives. The Sahm rule still calls for a recession, but, less likely, the warning is triggered without a subsequent recession.

It is important to remember that the current level is just below the recession threshold. We have experienced a level similar to where we are now four times since the 1960s, with no subsequent recession. Yet even based on current data, one might consider 2024 more likely than not. The main concern is that as an indicator of recent development it is necessarily adjusted to historical data. It therefore remains to be seen how it will continue to hold up for an extended “out-of-sample” period.

However, the logic behind this indicator is solid. It is important to note that the measurement should generally reach 0.5%; it reached slightly lower levels several times, around 0.4%, without triggering a recession. Once the 0.5% level is reached, unemployment tends to increase throughout the duration of a recession.

Other recession indicators

Other indicators suggest a recession could be coming. The yield curve is a relatively reliable indicator of recession over the medium term and has been signaling a recession for many months. Markets, too, as measured by the S&P 500 Index, have generally declined since July, suggesting some economic weakness may be coming. Also Key Economic Indicators from the Conference Board have been falling since April 2022, although these indicators incorporate variations in the measures already discussed, so it is not a completely unique indicator compared to others such as the stock market and the yield curve . Event forecasting site Kalshi currently weighs the probability of a recession in 2024 is around 50%. If we see a recession in 2024, it wouldn’t be a big surprise.

After that

The yield curve has been signaling a recession in the United States for some time. If the Sahm indicator joins it in predicting a recession, the probability of a recession in 2024 will increase according to most estimates. Events such as a possible government shutdown could further increase the risks of a recession in the United States. However, it is important to note that the Sahm indicator does not yet speak of a recession. Reports on upcoming jobs will be essential.