At the Money: Forecasting Recessions with Claudia Sahm

Episode Summary

Executive Summary: This podcast episode of Bloomberg's At the Money features host Barry Ritholtz and former Federal Reserve economist Claudia Somme discussing the Sahm Rule, a simple yet powerful recession indicator based on the unemployment rate. Somme explains the rule's perfect track record since the 1970s and why the post-pandemic economy may challenge historical patterns. The episode debunks persistent recession fears, attributing them to outdated models, and emphasizes the labor market as the key indicator for investors.

Main Topics: Nature and Characteristics of Recessions (Priority: 3/5): Discussion of what defines a recession as a broad-based contraction in economic activity, varying in depth and duration depending on the cause (e.g., 2008 financial crisis vs. 2001 dot-com bust). The Sahm Rule: Operation and Track Record (Priority: 5/5): Detailed explanation of the Sahm Rule, which triggers a recession signal when the three-month average unemployment rate rises 0.50 percentage points above its 12-month low. It has never triggered outside a recession since the 1970s and provides early warnings. Post-Pandemic Recession Predictions vs. Reality (Priority: 4/5): Analysis of why many economists wrongly predicted a recession post-pandemic, focusing on their overreliance on the 1970s inflation model, while COVID-related supply shocks and the war in Ukraine required different solutions. Potential Breakdown of the Sahm Rule in Current Context (Priority: 4/5): Somme acknowledges this cycle could be the one where the rule fails, as the labor market's unique post‑pandemic dynamics (catch‑up hiring, labor shortages) might let unemployment rise without triggering a full recession. Broader Post-Pandemic Economic Disruptions (Priority: 3/5): Exploration of other broken relationships, including housing, semiconductor shortages, and labor market tightness, which contrast with traditional recession patterns.

Key Arguments: The Sahm Rule is intentionally simple, using only the unemployment rate, because the labor market is the best single indicator of the U.S. economy. Most post-pandemic recession forecasts were based on outdated 1970s inflation patterns, ignoring that COVID and the war in Ukraine were supply shocks not solved by interest rate hikes. The Sahm Rule might 'break' this time because unemployment could trigger the 0.50% threshold and then plateau or decline, rather than continuing to rise into a recession. Investors should ignore persistent recession calls and instead focus on real‑time labor market data, especially the unemployment rate, to gauge recession risk. Many labor market relationships have broken post-pandemic (e.g., women's prime-age employment hit records), making historical comparisons less reliable.

Data Points: Sahm Rule trigger threshold: 0.50 percentage point increase in three-month average unemployment rate from 12-month low - The automatic trigger indicating the start of a recession Track record of Sahm Rule: Perfect since 1970s - It has never triggered outside a recession and always fires early in one Typical unemployment increase after Sahm Rule trigger: Almost 4 percentage points - Average increase from the low point; smallest in 2001 was 2 percentage points Number of recessions in past century: 17 - Provides perspective on the limited dataset for recession forecasting Time since two consecutive negative GDP quarters without a recession: 1947 - Demonstrates how unusual recent conditions are Unemployment rate in 2023: Lowest since 1960s - Occurred while inflation declined sharply, contradicting typical recession expectations

Pivotal Quotes: "The SOM rule looks for relatively small increases in the unemployment rate to say we're in a recession. Specifically, we look at the unemployment rate, the national unemployment rate, take the three-month average. We don't want to get faked out by the bumps and wiggles. We compare the most recent reading to the lowest of these three-month averages over the prior 12 months. If that difference is a half a percentage point or more, we are in a recession." — Claudia Somme: Explaining the operational mechanics of the Sahm Rule "If the SAMRO were going to break, it would be this time. And break in the sense that we could hit that half a percentage point trigger, and then the unemployment rate doesn't really rise that much more. We don't go into recession." — Claudia Somme: Acknowledging the possibility of the rule failing due to post-pandemic labor market disruptions "Many economists, many of my peers got stuck in the 1970s. In that we've had inflation went up. I mean, legitimately, in 2021, that was the first time in a long time we'd seen inflation above 2%. It spiked, it went up fast. The wisdom, if you knew nothing else and just saw inflation going up, typically you'd say, oh, okay, the Federal Reserve's got to step in, they've got to raise interest rates. And in the past, when the Fed has done that, it ends up in a bad place." — Claudia Somme: Critiquing the flawed logic behind most post-pandemic recession predictions

Implications: Investors should stop fixating on recession headlines and instead track the unemployment rate’s three-month moving average. If it rises 0.50% above its 12-month low, prepare for a downturn. Otherwise, the economy may continue to defy predictions, with the labor market as the most reliable compass.