Another recession indicator is close to flashing red.
The Sahm Rule, developed by economist Claudia Sahm, says that the US economy has entered a recession if the three-month average of the national unemployment rate has risen 0.5% or more from the previous 12-month low. The rule has successfully predicted recessions 100% of the time since the early 1970s.
If Friday's July jobs report reveals the unemployment rate rose to 4.2% during the month, the Sahm Rule would be triggered.
But economists, including Sahm herself, are cautious about such an outcome being used to conclude a recession is imminent for the US economy given the current economic backdrop.
"The rise in the unemployment rate is not as ominous as it would normally seem," Sahm wrote in a July 26 post on Substack.
Sahm reasons that the current uptick in unemployment doesn't account for recent shifts in the labor market that haven't been as common in prior occurrences where the Sahm Rule was triggered, including pandemic distortions of labor force participation and a massive increase in immigration.
"In past recessions, the share of entrants — those without work history or those returning to the labor force — fell," Sahm wrote. "The weakening in the labor market discourages them from looking for work. Currently, the entrant’s share is unchanged. That would be consistent with increased labor supply from immigrants pushing up unemployment and not a sign of weakening demand as is typical in a recession."
Bank of America Securities head of US economics Michael Gapen recently told Yahoo Finance he also doesn't see the Sahm rule as a useful recession tool in the current economic moment.
"The unemployment rate is rising largely because growth in the labor force from immigration is outpacing labor demand," Gapen said.
For now, Gapen said, the recent uptick in unemployment is not a story about firms cutting costs through more layoffs.
Asked whether he was worried about the Sahm rule getting triggered at a press conference Wednesday, Federal Reserve Chair Jerome Powell said, "The question really is one of are we worried about a sharper downturn in the labor market. The answer is we are watching carefully for that." He characterized the rule as a "statistical regularity." "It's not like an economic rule where it's telling you something must happen."
In the latest edition of Yahoo Finance's Chartbook, the Yardeni Research team submitted an alternative version of the Sahm rule that attempts to adjust for the inflow of immigrant workers.
Yardeni Research chief market strategist Eric Wallerstein opts to use the insured unemployment rate from weekly jobless claims data, which excludes new workers entering the labor force.
With this data, Wallerstein noted there is "little cause for concern that the labor market is cracking."
Even with the creator of the rule and others pointing out that a trigger of the Sahm rule from the July jobs report may not be the end all be all, market participants still think it could be significant to Friday's market action.
RBC Capital Markets head of US rates strategy Blake Gwinn wrote in a note to clients on Monday that such an event will push negative sentiment to "get turbocharged" and expects markets would quickly price in higher odds of a hard landing for the economy.
"We think a Sahm rule trigger this week would be less meaningful than in the past given the constellation of labor market data — but that isn’t going to matter on Friday, and we wouldn’t expect much sympathy for this view," Gwinn wrote.
Josh Schafer is a reporter for Yahoo Finance. Follow him on X @_joshschafer.
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