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Unemployment rate just 0.1% away from causing a major headache for the Fed: Morning Brief
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Despite the summer lull, the economic data calendar continues to heat up.
After last Friday monthly employment numbersInvestors will be treated to the latest Consumer Price Index inflation printout on Thursday, set up by Fed Chairman Jerome Powell, who will deliver his semiannual presentation Humphrey-Hawkins Testimony to the Senate on Tuesday and to the House on Wednesday.
“Data-dependent” Powell will no doubt do his best not to surprise investors when it comes to assessing the Fed twin mandates of maximum employment and stable prices.
But the latest economic data is increasing support for the Fed’s first rate cut since 2019 — especially after some surprise weakness on Friday in unemployment rate.
Investors can reasonably expect the Fed to hold firm at its July meeting in three weeks. But the odds of a September rate cut have been rising, now at 72% — up from 47% a month ago.
Last week, at a European Central Bank event in Portugal, Powell was asked directly whether the Fed might cut in September. Powell refused to answernoting that the Fed could afford to be patient given that the strong labor market is only gradually slowing.
But on Friday — just days after the event — the Bureau of Labor Statistics reported that the June unemployment rate had risen to 4.1%, surprising Wall Street, which had expected it to hold steady at 4.0%.
It’s a small difference and just one data point. But the unemployment rate is getting tantalizingly close to trigger a well-respected recession indicator called Sahm’s rule.
In short, the Sahm Rule warns that the U.S. economy is in the early stages of a recession if the three-month average of the unemployment rate has risen by half a percentage point or more from the low average over the previous 12 months. It is designed to detect an acceleration of job losses and has successfully predicted all nine previous U.S. recessions since 1970.
Starting in June, the reading It is now 0.43 ppts. Between now and the September meeting, there will be two more jobs releases (for July and August). If either of those prints is 4.2% or higher for the unemployment rate, the half-percent threshold for the Sahm Rule will have been reached, according to Yahoo Finance calculations.
Even if the Sahm Rule is triggered, the Fed has ample cover to do nothing — especially in an election year.
The story continues
Furthermore, Powell recently stated that he still wants to see more evidence that inflation is moving sustainably lower to his 2% target. So if Thursday’s CPI numbers rise substantially, you can bet that the odds of a September rate cut would likely fall to near zero.
Claudia Sahm, the former Federal Reserve economist who created the rule of the same name, also expressed doubts about the effectiveness of the rule in a world that is still normalizing after record unemployment during the pandemic.
But Sahm herself has been pushing for the Fed to act soon. In a recent interview with CNBC, she said that recession is a real risk, although it is not her base case.
“The worst possible outcome at this point is for the Fed to cause an unnecessary recession,” she said.
Depending on which jobs numbers fall in a month or two, we could easily face a barrage of headlines proclaiming that recession is near, as the focus shifts from inflation and stable prices to jobs and maximum employment. Just as with airplanes, the risks to an economy seem to increase just before landing.
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