Chart of the month: Is the US economy about to stall?

The ‘Sahm rule’, coined by US Federal Reserve (Fed) economist Claudia Sahm, has just been triggered. Her ‘rule-of thumb’ warns that if unemployment rises ½% above its 12-month low, a recession could be likely (N.B. based on using three-month averages).

This is similar to ‘stall-speed’ theory when flying planes. It’s based on the premise that if the economy slows by a certain amount, then self-reinforcing dynamics can take place. Greed moves to fear.

For instance, if companies run into trouble, then unemployment could rise. This, in turn, can cause households to struggle to pay their bills, causing further problems for companies. Household and corporate delinquencies rise as a result, causing banks to tighten credit conditions, and so on, and so forth.

There’s no theoretical ‘magic’ number for the dynamic to hold, and clearly past performance is not a guide to the future, but the ½% threshold identified has correlated with 11/12 of the last recessions. The only exception was a premature warning in 1959. We discount the 2003 episode as that was an aftershock from the dot.com recession.

The latest unemployment data has seen the three-month average of unemployment rise from 3.6% a year ago to 4.13% today – a rise of 0.53%, triggering the Sahm rule. This backdrop is increasing growth fears, which in turn is pushing bond yields down.

However, the good news is that the inflation backdrop is much better than a year ago, so we believe the US Federal Reserve could be better placed to ease policy aggressively if growth fears materialise.