Evelyn Reynolds

Economist Claudia Sahm has shown that when the unemployment rate’s three-month average is half a percentage point higher than its 12-month low, the economy is in recession.
Sahm said the Fed is taking a big risk by not moving now with gradual cuts.
Fed officials last week sharply lowered their individual forecasts for rate cuts this year, going from three expected reductions at the March meeting to one this time around.

Economist Claudia Sahm on CNBC’s The Exchange.

The Federal Reserve is risking tipping the economy into contraction by not cutting interest rates now, according to the author of a time-tested rule for when recessions happen.
Economist Claudia Sahm has shown that when the unemployment rate’s three-month average is half a percentage point higher than its 12-month low, the economy is in recession.

As the jobless level has ticked up in recent months, the “Sahm Rule” has generated increasing talk on Wall Street that what has been a strong labor market is showing cracks and pointing to potential trouble ahead. That in turn has generated speculation over when the Fed finally will start reducing interest rates.
Sahm, chief economist at New Century Advisors, said the central bank is taking a big risk by not moving now with gradual cuts: By not taking action, the Fed risks the Sahm Rule kicking in and, with it, a recession that potentially could force policymakers to take more drastic action.
“My baseline is not recession,” Sahm said. “But it’s a real risk, and I do not understand why the Fed is pushing that risk. I’m not sure what they’re waiting for.”
“The worst possible outcome at this point is for the Fed to cause an unnecessary recession,” she added.

Flashing a warning sign

As a numeric reading, the Sahm Rule stood at 0.37 following the May employment report from the Bureau of Labor Statistics that showed the unemployment rate rising to 4% for the first time since January 2022. That’s the highest the Sahm reading has been on an ascending basis since the early days of the Covid pandemic.

The value essentially represents the percentage point difference from the three-month unemployment rate average compared to its 12-month low, which in this case is 3.5%. A reading of 0.5 would represent an official trigger for the rule; a couple more months of 4% or better readings on the unemployment rate would make that happen.
The rule has applied for every recession dating back to at least 1948 and thus works as an effective warning sign when the value starts to increase.
Even with the rising jobless level, Fed officials have expressed little concern about the labor market. Following its meeting last week, the rate-setting Federal Open Market Committee labeled the jobs market as “strong,” and Chair Jerome Powell at his press conference said conditions “have returned to about where they stood on the eve of the pandemic — relatively tight but not overheated.”
In fact, officials sharply lowered their individual forecasts for rate cuts this year, going from three expected reductions at the March meeting to one this time around.
The move surprised markets, which still are pricing in two cuts this year, according to the CME Group’s FedWatch measure of fed funds futures market contracts.
“The bad outcomes here could be pretty bad,” Sahm said. “From a risk management perspective, I have a hard time understanding the Fed’s unwillingness to cut and their just ceaseless tough talk on inflation.”

‘Playing with fire’

Sahm said Powell and his colleagues “are playing with fire” and should be paying attention to the rate of change in the labor market as a potential harbinger of danger ahead. Waiting for a “deterioration” in job gains, as Powell spoke of last week, is dangerous, she added.
“The recession indicator is based on changes for a reason. We’ve gone into recession with all different levels of unemployment,” Sahm said. “These dynamics feed on themselves. If people lose their jobs, they stop spending, [and] more people lose jobs.”
The Fed, though, finds itself at a bit of a crossroads.
Tracking a recession where the unemployment rate starts this low requires a trip all the way back to the latter part of 1969 into 1970. Moreover, the Fed rarely has cut rates with unemployment at this level. Central bankers in recent days, including on several occasions Tuesday, have said they see inflation moving in the right direction but don’t feel confident enough to start cutting yet.
By the Fed’s preferred barometer, inflation ran at 2.7% in April, or 2.8% when excluding food energy prices for the core reading that policymakers especially zero in on. The Fed targets inflation at 2%.
“Inflation has come down a lot. It’s not where you want it to be, but it is pointed in the right direction. Unemployment is pointed in the wrong direction,” Sahm said. “Balancing these two out, you get closer and closer to the danger zone on the labor market and further away from it on the inflation side. It’s pretty obvious what the Fed should do.” More

Retail sales rose 0.1% in May, below the 0.2% the Dow Jones estimate. Excluding autos, sales declined 0.1%.
Moderating gas prices helped hurt receipts at gas stations, which reported a 2.2% monthly decline.
Following the retail data, traders in the fed funds futures market upped their bets that the Fed would cut interest rates this year.

A worker assists with check-out at a Costco store in Teterboro, New Jersey, US, on Wednesday, Feb. 28, 2024. 
Stephanie Keith | Bloomberg | Getty Images

Retail spending was weaker than expected in May as consumers continued to wrestle with stubbornly higher levels of inflation.
Sales rose just 0.1% on the month, one-tenth of a percentage point below the Dow Jones estimate, according to a Commerce Department report Tuesday that is adjusted for seasonality but not inflation. However, the result was slightly better than the downwardly revised 0.2% decline In April.

On a year-over-year basis, sales rose 2.3%.
The sales number was worse when excluding autos, with a decline of 0.1% against the estimate for a 0.2% increase.
Moderating gas prices helped hurt receipts at gas stations, which reported a 2.2% monthly decline. That was offset somewhat by a 2.8% increase at sports goods, music and book stores.
Online outlets reported a 0.8% increase, while bars and restaurants saw a 0.4% decline. Furniture and home furnishing stores also reported a 1.1% drop.
Stock market futures were around flat following the report while Treasury yields declined.

The report comes with investors on edge about the direction of the economy and what that will mean for the future of monetary policy at the Federal Reserve. Consumer spending is responsible for about two-thirds of all economic activity, so any weakness could signal both a retrenchment in growth while also pushing the Fed to begin cutting interest rates.
Inflation numbers of late have been somewhat encouraging, but spending is showing signs of weakening as consumers have been under pressure from rising prices for more than two years.
A Commerce Department measure that the Fed uses as its main gauge for inflation showed an annual rate of 2.7% in April, or 2.8% when excluding food and energy. The Fed targets 2% inflation.
Market pricing is pointing to the equivalent of two interest rate reductions this year of a quarter percentage point each, though Fed officials at their meeting last week indicated the likelihood of just one. Following the retail data, traders in the fed funds futures market upped their bets that the Fed would be easing, even pricing in about a 23% chance of three cuts this year, according to the CME Group’s FedWatch gauge.
Philadelphia Fed President Patrick Harker said Monday that it would be appropriate to cut rates later this year only if the data cooperate, and said he envisions the likelihood of just one move lower. More

The BOJ said in its statement it could reduce its purchases of Japanese government bonds after the next monetary policy meeting, scheduled to be held on July 30 and 31.
During the intermeeting period, the BOJ said it will collect views from market participants and will decide on a detailed plan for the reduction of its purchase amount during the next one to two years or so.

The Bank of Japan is largely expected to hold interest rates steady at the end of its 2-day meeting ending June 14, 2024. Seen here, the Japanese flag flying high at the BOJ headquarters in Tokyo.
Kazuhiro Nogi | Afp | Getty Images

The Bank of Japan kept its benchmark interest rate unchanged on Friday, but indicated it’s considering the reduction of its purchase of Japanese government bonds.
The central bank left short-term rates unchanged at between 0% to 0.1% at the end of its two-day policy meeting, as widely expected.

But notably, the bank said in its statement it could reduce its purchases of Japanese government bonds after the next monetary policy meeting, scheduled for July 30 and 31.
The decision was passed with an 8-1 majority vote, with board member Nakamura Toyoaki dissenting.
Toyoaki was in favor of reducing JGB purchases, but is of the view that the BOJ should only decide to reduce them after reassessing developments in economic activity and prices in the July 2024 outlook report, slated for July 31.
Ahead of the next meeting, the BOJ said it will collect views from market participants and will decide on a detailed plan for the reduction of its purchase amount for the next one to two years.
Purchases of JGBs, commercial paper and corporate bonds will also continue as decided in the March monetary policy meeting.

Following the BOJ decision, the Japanese yen weakened 0.52% to 157.84 against the U.S. dollar, while the yield on 10-year JGB fell 44 basis points to 0.924.
The benchmark Nikkei 225 rose 0.68%, reversing earlier losses, while the Topix was 0.71% higher.

Bold policy moves

In March, the BOJ raised interest rates for the first time in 17 years — ending the world’s last negative rate regime — and scrapped the yield curve control policy in a radical policy move.
However, the central bank said at that time it would continue to purchase JGBs at a pace of about 6 trillion yen ($38.17 billion) per month.
While the large scale purchases of JGBs achieved the effect of stabilizing 10-year JGB yields at around the 1% level, it indirectly put additional downward pressure on the weak yen, according to a note by advisory firm Teneo published on June 13.

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On May 8, BOJ governor Kazuo Ueda said the central bank will scrutinize the yen’s recent declines in guiding monetary policy, according to a Reuters report.
It came after the yen slipped to a 34-year low, trading at 160 against the dollar in late April, which prompted the BOJ to intervene to prop up the currency.
“Sharp, one-sided yen falls are negative for the economy and therefore undesirable,” as it makes it difficult for companies to set business plans, Ueda told parliament.
“If currency volatility affects, or risks affecting, trend inflation, the BOJ must respond with monetary policy,” he added. More

The producer price index, a gauge of prices that producers get for their goods and services in the open market, declined 0.2% for the month against expectations for a 0.1% increase.
PPI was held back by a 0.8% decrease in final demand goods prices, which was the largest decline since October 2023.
In other economic news, initial claims for unemployment insurance jumped to 242,000 for the week ended June 8. That’s the highest level since August 2023.

A measure of wholesale prices unexpectedly decreased in May, adding another piece of evidence that inflation is pulling back.
The producer price index, a gauge of prices that producers get for their goods and services in the open market, declined 0.2% for the month, the Labor Department’s Bureau of Labor Statistics reported Thursday. That reversed a 0.5% increase in April and compared with the Dow Jones estimate for a 0.1% rise.

Excluding food, energy and trade services, the PPI was unchanged, compared with expectations for a 0.3% increase.
On an annual basis, the all-items PPI rose 2.2%.
Stock market futures saw some modest gains following the report while Treasury yields moved lower.
The release comes a day after the BLS reported that the consumer price index, a widely watched gauge of inflation that measures what consumers actually pay for goods and services, was unchanged on the month.
From the wholesale perspective, the PPI was held back by a 0.8% decrease in final demand goods prices, which was the largest decline since October 2023. Within the category, the energy index tumbled 4.8%. Food prices fell 0.1%.

On the services side, fuels and lubricants retailing margins surged 12.2%, but that was offset in part by a 4.3% plunge in airline passenger services prices.
The release comes a day after the Federal Reserve noted “modest further progress” in bringing inflation back down to its 2% target, but not enough for the central bank to start lowering interest rates. The Fed has held its benchmark borrowing rate in a targeted range of 5.25%-5.5% since July 2023 as it awaits more evidence that inflation is heading back to the central bank’s 2% target.
In other economic news Thursday, the Labor Department reported that initial claims for unemployment insurance jumped to 242,000 for the week ended June 8. That’s the highest level since August 2023 and an increase of 13,000 from the previous period. Economists surveyed by Dow Jones had been looking for 225,000.
Continuing claims, which run a week behind, totaled 1.82 million, up 30,000 from the previous week.

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