U.S. economy is ‘one step closer’ to triggering dreaded 'Sahm Rule'

Although the U.S. job market exceeded expectations with 206,000 new jobs in June, economists warn that this figure masks a major recession signal.

Despite the solid hiring pace, the unemployment rate rose from 4% to 4.1%, the highest since November 2021, when the economy was still recovering from Covid lockdowns.

According to Paul Ashworth, chief North America economist at Capital Economics, the increase puts the economy “one step closer to triggering the Sahm Rule.”

In economics, the Sahm Rule signals the start of a recession when the unemployment rate’s three-month average increases by 0.5% or more from its low during the previous 12 months.

June marked the third consecutive month of rising unemployment, meaning that another uptick would trip the Sahm recession signal.

It’s not the first time that experts have raised red flags about the supposedly strong labor market.

In May, Bloomberg editor Edward Harrison said, outside of Covid, the unemployment rate’s three-month average was rising at the fastest clip since 2010.

The Sahm indicator is easy to ignore when the unemployment rate is hovering near historic lows. But as Harrison explained, it's all about how fast things can unravel when joblessness begins to creep up.

By definition, “the unemployment rate is always at its lowest right before a recession,” he explained.

Calm before the storm?

The U.S. economy had a terrible start to the year, marked by rising inflation and slumping GDP growth.

In May, the Bureau of Economic Analysis reported that the economy grew just 1.6% in the first quarter. Government economists have since revised that figure to 1.3%—a typical downward update.

Economists say the slowdown will continue as consumers cut back on discretionary spending due to inflation and falling disposable incomes.

“The weaker personal income and spending numbers, together with the downward revisions to consumption growth for the first quarter, have raised concerns that the core engine of the economy is slowing,” wrote Michael Pearce, Oxford’s deputy chief U.S. economist.

Meanwhile, global investment manager Russell Investments sees an “elevated” risk of recession this year, which makes the Fed’s job of engineering a soft landing much more difficult.

“If the Fed cuts rates too much, economic growth and inflation could reaccelerate. If the Fed cuts rates too little, the U.S. economy could still fall over into recession,” said Russell Investments’ senior investment strategist Paul Eitelman.

There’s a growing belief that the Fed would intervene if it believes the economy is heading for a recession.

However, according to several economists, the Fed is waiting too long, which means central bankers will likely be playing catch-up if a recession materializes.