The Federal Reserve risks bringing the US economy into a downturn if it does not lower interest rates now, according to the author of a time-tested rule predicting when a recession occurs.
Economist Claudia Sahm has demonstrated through her rule that when the three-month average unemployment rate is half a percentage point higher than its 12-month low, the economy is in a recession.
As the unemployment rate has risen in recent months, “Sahm’s Rule” has sparked discussions on Wall Street, indicating that the previously stable labor market may be weakening and hinting at potential economic problems. These speculations have led to debates about when the Federal Reserve may begin to lower interest rates.
Sahm’s Rule measures the difference in percentage points between the three-month average unemployment rate and its 12-month low, which currently stands at 3.5%. A result of 0.5 would trigger the rule, with only a few more months of unemployment at 4% or higher potentially activating it.
This rule has been a reliable indicator of recession since at least 1948 and serves as an effective early warning signal when its value increases.
Sahm noted that the central bank is taking a significant risk by not gradually starting to lower interest rates now. According to her, inaction could trigger the rule, potentially leading to a recession that may force the Fed to implement more drastic measures.
According to the latest data from the Bureau of Labor Statistics, the “Sahm Rule” reached a level of 0.37 after the May employment report, which recorded an increase in the unemployment rate to 4% for the first time since January 2022. This is its highest increase since the early stages of the Covid pandemic.
Sahm believes that Powell and his colleagues are “playing with fire” by not paying more attention to the changes in the labor market. She criticized the Fed’s approach to waiting for a decline in job growth, as mentioned by Powell, calling it risky.