As soon as the U.S. Nonfarm Payrolls report for July was released, fears of a hard landing for the economy surged. One key reason behind this panic was that the report triggered one of the indicators used to track economic recessions: the Sahm Rule. However, what exactly is this mysterious rule? Below we will break it down for you.
What is the Sahm Rule?
The Sahm Rule was discovered by Federal Reserve economist Claudia Sahm. It primarily uses labor market data as a benchmark and is calculated as follows: the three-month moving average of the U.S. unemployment rate minus the lowest unemployment rate from the previous year. If the resulting value exceeds 0.5%, it strongly suggests that the economy has entered a recession.
Claudia Sahm is the Chief Economist at New Century Advisors, the founder of Sahm Consulting, and a former Federal Reserve economist. She served as an economist at the Federal Reserve since 2007 and was also an economic advisor during the Obama administration.
How accurate has the Sahm Rule been historically?
The following table compiles past instances when the Sahm Rule first exceeded the 0.5% threshold. Out of 11 occurrences, 10 were followed by an official economic recession (as defined by the National Bureau of Economic Research). The only exception was in 1960, where a recession began shortly after the indicator was triggered.
Relationship Between Sahm Indicator and Recessions
| Date | Sahm Indicator (%) | Unemployment Rate (%) | Recession Start Date | Time Lag |
|---|---|---|---|---|
| Nov 1953 | 0.63 | 3.50 | Jul 1953 | 4 months later |
| Oct 1957 | 0.5 | 4.50 | Aug 1957 | 2 months later |
| Nov 1959 | 0.6 | 5.80 | Apr 1960 | 5 months earlier |
| Mar 1970 | 0.77 | 4.40 | Dec 1969 | 3 months later |
| Jul 1974 | 0.6 | 5.50 | Nov 1973 | 8 months later |
| Feb 1980 | 0.53 | 6.30 | Jan 1980 | 1 month later |
| Nov 1981 | 0.6 | 8.30 | Jul 1981 | 4 months later |
| Oct 1990 | 0.53 | 5.90 | Jul 1990 | 3 months later |
| Jun 2001 | 0.5 | 4.50 | Mar 2001 | 3 months later |
| Feb 2008 | 0.53 | 4.90 | Dec 2007 | 2 months later |
| Apr 2020 | 4.0 | 14.80 | Feb 2020 | 2 months later |
U.S. Employment Trends After the Indicator is Triggered
The Sahm Rule captures the short-term upward trend in unemployment. Looking at other U.S. employment indicators, we can see that six months after the rule is triggered, the number of initial jobless claims typically increases by nearly 100,000, and the unemployment rate continues to rise over the next year.
| 3 Months | 6 Months | 12 Months | |
|---|---|---|---|
| Change in Initial Jobless Claims | 80,470 | 99,810 | 35,960 |
| Change in Unemployment Rate | 0.68 | 0.98 | 1.32 |
Current Employment Situation
As of now, the U.S. unemployment rate has risen to 4.3%, and the Sahm Indicator has reached 0.53%. However, it’s important to note that this is the first time in recent months that the indicator has exceeded the threshold, so declaring a recession requires more evidence. Claudia Sahm herself has stated that the indicator should not be relied upon in isolation and that a broader assessment of economic conditions is necessary—she believes the U.S. economy has not yet entered a recession.
Next, let's dive into the data and analyze the current state of employment in the U.S.
Rising Labor Force Participation & More Immigrants Entering the Workforce
First, labor force participation has increased, with the prime-age (25–54 years old) labor force participation rate reaching a record high. This suggests that more people are seeking employment, which in turn pushes up the unemployment rate in statistical terms. Typically, during a recession, labor force participation tends to decline.
Currently, the increase in labor supply is being driven by higher immigration. More immigrants are entering the job market, contributing to the rise in the unemployment rate. The number of employed immigrants has grown, but the total number of job seekers has risen even more, making the unemployment rate appear higher than it actually is. This could be amplifying the perceived increase in unemployment.
Labor Force Participation Rate = (Employed Population + Unemployed Population) / Total Labor Force × 100%
Unemployment Rate = Unemployed Population / Total Labor Force × 100%
Additionally, the recent decline in employment mainly stems from the service sector. However, the U.S. Services PMI released on August 5 came in at 51.4, significantly above the previous reading of 48.8. Businesses have reported strong demand, with some noting that election-related uncertainties have temporarily delayed orders. If demand rebounds, employment could be supported, leaving uncertainty over whether the unemployment rate will continue to rise.
Conclusion
The Sahm Rule is a useful tool for quickly summarizing current employment trends. However, as its creator Claudia Sahm has advised, investors should be mindful of specific economic conditions and temporary distortions before drawing conclusions.
