Economist Claudia Thurm appears on CNBC’s The Exchange.
CNBC
According to the authors of the time-tested rules for when a recession occurs, the Fed risks plunging the economy into contraction by not cutting interest rates now.
Economist Claudia Thurm has shown that an economy is in recession when the three-month average of the unemployment rate is half a percentage point higher than its 12-month low.
As unemployment has risen in recent months, there has been growing speculation on Wall Street that the “Thumb Rule” is showing cracks in a previously robust labor market that could lead to problems down the road, stoking speculation about when the Fed might finally start cutting interest rates.
Sam, the chief economist at New Century Advisors, said the Fed was taking a big risk by not cutting rates gradually now, warning that inaction could trigger the Sam rule, which would lead to a recession and force policymakers to take more drastic action.
“My base case is not a recession,” Sam said. “But it’s a real risk and I don’t understand why the Fed is pushing that risk. I don’t know what the Fed is waiting for.”
“The worst possible outcome at this point is that the Fed creates an unnecessary recession,” she added.
Flashing warning signs
Numerically, the Sumrule stood at 0.37 after the Bureau of Labor Statistics’ May jobs report showed the unemployment rate rose to 4% for the first time since January 2022. This is the highest Sumrule has recorded on an upward basis since the early days of the COVID-19 pandemic.
This value is essentially the difference in percentage points between the three-month unemployment average and the 12-month minimum unemployment rate (3.5% in this case). The 0.5 number is the official trigger for this rule, which will be triggered if the unemployment rate stays above 4% for a few more months.
This rule has been applied to every recession going back to at least 1948, and therefore serves as an effective warning sign when values start to rise.
Despite the rising unemployment rate, Fed officials have expressed little concern about the labor market. After meeting last week, the interest-rate-setting Federal Open Market Committee assessed the job market as “strong,” and Chairman Jerome Powell said at a news conference that conditions are “back to roughly where they were on the eve of the pandemic, relatively tight but not overheating.”
Indeed, officials sharply lowered their forecasts for rate cuts this year, down from three cuts anticipated at the March meeting to one this time.
The move surprised markets, which are still pricing in two rate cuts this year, according to FedWatch, an index of CME Group’s federal funds futures market contract.
“A bad outcome here could be pretty bad,” Sam said. “From a risk management perspective, it’s hard to understand the Fed’s reluctance to cut rates or its refusal to back down on inflation.”
‘Playing with Fire’
Tham said Powell and his colleagues are “playing with fire” and should pay close attention to the rate of change in the labor market as a harbinger of future dangers. Waiting for a “worse” in job growth, as Powell said last week, is dangerous, he added.
“Recession indicators are based on change for a reason. Recessions happen at different levels of unemployment,” Sam said. “These dynamics amplify themselves. When people lose their jobs, they stop spending; [and] More people will lose their jobs.”
But the Fed finds itself at something of a crossroads.
You would have to go back to late 1969 and 1970 to track down a recession that started with unemployment that low. What’s more, the Fed has rarely cut interest rates when unemployment is at this level. Central bank officials have said in recent days, and several times on Tuesday, that they see inflation moving in the right direction but aren’t confident enough to start cutting rates.
Inflation, measured by the Fed’s preferred measure, was 2.7% in April, and 2.8% excluding food and energy prices, a core measure closely watched by policymakers. The Fed has a 2% inflation target.
“Inflation has come down significantly. It’s not where we want it to be, but it’s heading in the right direction. The unemployment rate is heading in the wrong direction,” Sam said. “When you balance the two, you get the labor market moving closer and closer to the danger zone and inflation moving away from it. It’s clear what the Fed needs to do.”
