Just after the Federal Open Market Committee meeting of the Federal Reserve Bank, where it was again decided to leave the Federal Funds Rate target intact, the employment report for last July was published on Friday, which caused a strong adjustment (selloff) in financial markets in the face of possible evidence of a recession. Has the Fed continued to get things wrong?
The Labor Department’s report told us that 114,000 jobs were created last month, against an expectation of 175,000 jobs, and 206,000 jobs were created in June. The unemployment rate rose to 4.3 percent from 4.1 percent previously, and wages (average earnings per hour worked) are increasing at 3.6 percent annually, compared with 4.2 percent in June.
At first glance, the data is weaker than analysts had expected, so markets should react optimistically to the confirmation that the interest rate cut cycle, which analysts have been expecting for more than a year, is finally coming. But the markets’ reaction was terrible.
The Nikkei Index on the Tokyo Stock Exchange fell 5.73 percent; the German Dax fell 2.33 percent; the FTSE in London, -1.31 percent; the Nasdaq, -2.43 percent; the S&P 500, -1.84 percent. Not only did the stock market fall, but also WTI oil fell 2.84 percent and bitcoin, -4.30 percent. The Mexican peso was the most affected currency, with a depreciation of 1.77 percent. Gold as a safe haven asset appreciated 0.21 percent. The negative reaction is that these data activated what is known as the Sahm rule. An early recession indicator complementary to the inverted yield curve in treasury bonds, which has also been present for several months, and which is monitored in real time by the Federal Reserve of St. Louis.
This recipe, devised by former Federal Reserve economist Dr. Claudia Sahm, says that when the three-month average unemployment rate is 0.5 percent above the 12-month low, a recession is either coming or already in progress. A few months ago, the unemployment rate hit 3.8 percent; now it is reported at 4.3 percent. Since 1953, and not counting this latest trigger, the Sahm rule has worked 11 times, and 10 of those times the economy was already in recession. The only misreading of the rule was in 1959, when the recession began five months after the Sahm rule was triggered.
But Dr. Claudia Sahm herself has warned that the rule cannot be read that strictly. Earlier this year she said at an academic conference that her theorem might ever fail to predict a recession, and gave the example of predicting a recession this year. In a Substack post from a few days ago she said that “the rise in the unemployment rate is not as ominous as it would normally appear.” And this is because much of the rise in the unemployment rate over the past year has been driven not by job layoffs but by an increase in labor supply due to immigration trends, and I would add to that the increase in labor market participation. “The Sahm rule is likely to exaggerate the weakening of the labor market due to unusual changes in labor supply caused by the pandemic and immigration,” Sahm has said.
Another major problem with Friday’s report is that July’s statistics are affected by Hurricane Beryl. Bureau of Labor Statistics data shows that 436,000 people were unable to work because of the hurricane and 1.08 million more people who normally work full-time were only able to find part-time work because of the weather.
Last week I mentioned the premature economic weakness that Mexico has been experiencing since the second quarter. The political uncertainty generated by the possible reform of the Judiciary, insecurity, corruption, the lack of rule of law and the elections in the US are factors that can cause a slowdown in productive investment, but if a recession scenario is added to this, 2025 seems to be much more complicated and could lead us to a recession, and to problems in tax collection, in the fiscal deficit and in the sovereign risk rating.
