The US Sahm rule was created by Claudia Sahm, a former economist at the Bureau of Labour Statistics in the US. The Sahm rule was designed to serve as an early warning sign of a recession in the US based on changes in the unemployment rate.
In terms of predicting recession, the Sahm rule compares the three-month moving average of the national unemployment rate with the lowest three-month moving average unemployment rate in the past 12-month. If the difference is more than 0.50 percentage points, then this would indicate that a recession is off to a start. When this rule is triggered, it simply suggests that unemployment rate has accelerated at a fast pace in the past 13 months, which also means that unemployment rate could deviate from the natural rate of unemployment.
If the Sahm rule is described as an early recession warning indicator, it is important to assess if the rule has effectively predicted recession in the past. Although the rule was designed in 2019, this article tested the forecasting prowess of the Sahm rule from March 2014 to date. Over this test period, the US economy had one episode of recession in Q2-20 after witnessing a contraction of 1.36% Q/Q in Q1-20 and 7.89% Q/Q in Q2-20. The Sham rule recession signal clearly signalled the recession in Q2-20, but goes further until Q1-21, which conflicts with economic growth reported post-Q2-20. With more recession period data, a more robust validation of the Sahm rule can be conducted. However, based on the data used by this article, we conclude that the Sahm rule does provide a signal for recession.
Having established that reliance can be placed on the Sahm rule, the estimated value, which has been below the 0.5ppt, printed at 0.53ppt in Jul-24 compared to 0.43ppt in Jun-24 having risen steadily since Feb-24. Correspondingly, the unemployment rate has climbed from 3.9% Y/Y in Feb-24 to 4.3% Y/Y in Jul-24. With the Sahm rule triggered, it is now apparent that the Fed is caught between a rock and a hard place. Should they fail to cut rate at the September meeting, the move will likely be described by many as a policy mistake.
Written by Michael Ogunremi
Image credit – Pexels