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Aggressive rate cuts seem to be on the horizon, as a key economic indicator suggests the US Federal Reserve might be behind the curve in dealing with an impending recession.
The Sahm Recession Indicator is an economic rule of thumb that signals the start of a recession when the three-month average US unemployment rate rises by 0.50% or more from its 12-month low.
Sahm Uptick And Aggressive Cuts
Created in 2019 by economist Claudia Sahm, this indicator has already crossed the critical 0.50% threshold after the country's unemployment rate rose to the highest level in nearly three years. While, interest rates remained at an over two-decade high.
Historically, elevated Sahm levels have always been followed by aggressive rate reductions, such as those after the dot-com bubble burst in 2001, the 2008 financial crisis, and the Covid-19 pandemic in 2020.
In 2001, as the dot-com bubble burst, the recession indicator surpassed the 0.5-mark in June, prompting the Fed to slash rates from 3.75% to 1.75% by the year's end.
Similarly, in 2008, the indicator breached 0.50% by the June quarter, signaling a recession. Although the Fed eventually reduced rates from 2.00% to 0.25% by the end of the year, this came after the economic collapse had accelerated.
The Covid-19 pandemic in 2020 saw the indicator skyrocket to 9.50%, with the Fed slashing rates to near-zero almost simultaneously.
What After September?
Economists expect Fed Chair Jerome Powell to announce a 25 basis-point rate cut in the upcoming decision on Wednesday. Traders have fully priced in one rate cut, while 49% see an additional cut, according to Bloomberg data.
The Federal Open Market Committee anticipates a soft landing for the US economy in 2024, that includes slowing GDP growth but no recession.
However, as of September 2024, the New York Fed suggests a 62% probability of a recession in the next 12 months. A recession probability of over 60% has not been suggested since the early 1980s.
Supporting this, the Sahm Rule also stands at 0.57%, suggesting that the Fed might be behind the curve. If the Fed follows its historical pattern, significant rate reductions could soon be coming.
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