The Sahm Rule Recession Indicator is a straightforward yet potent tool that tracks the national unemployment rate to signal potential recessions. Created by economist Claudia Sahm, this real-time indicator is supposed to provide an early warning by examining the unemployment rate’s three-month moving average.
Potential of upcoming Recession ➖
The background
The Sahm Rule Recession Indicator emerged from the discerning observation of economist Claudia Sahm while she was with the Federal Reserve, where she noted a consistent pattern of rising unemployment rates during the onset of past recessions.
Sahm, leveraging her expertise as a principal economist in the Division of Research and Statistics at the Federal Reserve, proposed this rule as a mechanism to signal the start of a recession based on the three-month moving average of the national unemployment rate.
The rule triggers a recession alert if this average rises by at least 0.50 percentage points relative to its low over the previous 12 months.
The Sahm Rule was formally introduced to the public domain through the Federal Reserve Economic Data (FRED) system of the St. Louis Federal Reserve Bank in October 2019.
This publication allowed for a retroactive evaluation of the Sahm Rule’s performance across past recessions. One of the defining characteristics of this rule is its reliance on a single data series, the national unemployment rate, which is published monthly.
This singular focus distinguishes the Sahm Rule from other recession indicators that might rely on multiple data inputs, making it a straightforward yet effective tool for real-time economic evaluation.
The metrics
| Indicator | Current Status | R? |
|---|---|---|
| Unemployment up 50points from its 12month low | Up just under 50 basis points from low | ➖ |
The Sahm Rule Recession Indicator is fundamentally driven by the national unemployment rate, distilled into a three-month moving average to temper the effects of short-term variations.
The pivotal metric is a rise of 0.50 percentage points in this moving average from its low over the preceding 12 months. This precise increase serves as a red flag for potential recessionary conditions.
The data underpinning this indicator is sourced from the monthly published national unemployment rate, allowing for a timely assessment of the economy’s trajectory.
This comparison with historical unemployment rate lows over a defined period provides a relative gauge of the unemployment trend, crucial for anticipating economic shifts.
The narrative
When the three-month moving average of the unemployment rate ascends by at least 0.50 percentage points from its low over the previous 12 months, it often signifies a contraction in job opportunities.
This contraction can be spurred by various factors such as reduced consumer spending, decreased business investment, or other economic stressors.
As businesses grapple with these challenging economic conditions, hiring decelerates and eventually people are laid off, leading to a rise in unemployment.
Based on current employment levels in the USA, a change of 50 basis points is roughly 840,000 Americans moving from employed to unemployed.
It’s important to understand the human factor in this data. Oftentimes, as a business owner, you’ll try whatever you can do to save costs before moving to laying people off. It tends to be the cost cutting of last resort.
For this reason, the unemployment levels might take longer to show the effect of a challenging business environment.
Where are we?
The chart shows unemployment is up 20 basis points from it’s 12 month low. This is not a signal of a recession but it is certainly on an upward trajectory.
Given that employment (or, unemployment) is generally considered a lagging indicator, and that unemployment levels historically will jump up quickly once they start to move, the fact we are up off the lows could well be perceived as an early warning signal.
In isolation, however, this is not enough to indicate a recession.
No current indication of a recession ➖
Acknowledgements
The Sahm Rule Recession Indicator was developed by economist Claudia Sahm while at the Federal Reserve, and later introduced to the public through the Federal Reserve Economic Data (FRED) system of the St. Louis Federal Reserve Bank in October 2019. All credit goes to Claudia.
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