Economist Claudia Sahm on CNBC’s The Exchange.
CNBC
The Federal Reserve risks sending the economy into a downturn if it doesn’t cut interest rates now, according to the author of a tried-and-tested rule for recessions.
Economist Claudia Sahm has shown that the economy is in recession when the three-month average unemployment rate is half a percentage point above its 12-month low.
As the number of unemployed people has risen in recent months, Wall Street’s “Sahm Rule” has sparked increasing rumors that the previously strong labor market is showing cracks, pointing to possible problems ahead. This, in turn, has led to speculation about when the Fed will finally start cutting interest rates.
Sahm, chief economist at New Century Advisors, said the central bank is taking a big risk if it doesn’t make gradual cuts now: If the Fed doesn’t take action, it risks having the Sahm rule kick in and with it a recession could possibly lead to politicians having to take more drastic measures.
“My starting point is not a recession,” Sahm said. “But it’s a real risk, and I don’t understand why the Fed is increasing this risk. I’m not sure what she’s waiting for.”
“The worst thing that could happen at this point would be for the Fed to cause an unnecessary recession,” she added.
A warning sign flashes
As a numerical value, the Sahm rule was 0.37 after the Bureau of Labor Statistics’ May employment report showed that the unemployment rate rose to 4% for the first time since January 2022 on a basis since the early days of the Covid pandemic.
The value essentially represents the percentage difference between the three-month average unemployment rate and its 12-month low, which in this case is 3.5%. A value of 0.5 would constitute an official trigger for the rule; A few more months of unemployment at 4% or better would make this possible.
The rule applies to every recession since at least 1948, so it acts as an effective warning signal when the value begins to rise.
Despite the rising unemployment rate, Fed officials have expressed few concerns about the labor market. After its meeting last week, the Federal Open Market Committee, which sets interest rates, called the labor market “strong,” and Chairman Jerome Powell said at his news conference that conditions are “about back to where they were the night before.” the pandemic – were relatively tense.” but not overheated.
In fact, officials have significantly lowered their individual forecasts for rate cuts this year, from three cuts expected at the March meeting to one this time.
The move surprised markets, which are still pricing in two interest rate cuts this year, according to CME Group’s FedWatch gauge of fed fund futures market contracts.
“The bad results here could be pretty bad,” Sahm said. “From a risk management perspective, I have a hard time understanding the Fed’s unwillingness to cut rates and their just incessant tough talk about inflation.”
‘Playing with fire’
Sahm said Powell and his colleagues were “playing with fire” and should pay attention to the rate of change in the labor market as a potential harbinger of the danger ahead. Waiting for employment gains to “deteriorate,” as Powell talked about last week, is dangerous, she added.
“The recession indicator is based on change for a reason. We have entered a recession with varying levels of unemployment,” Sahm said. “This dynamic feeds on itself. When people lose their jobs, they stop spending money, [and] more people are losing their jobs.”
However, the Fed is at a crossroads.
To trace a recession where the unemployment rate starts so low, you have to go back to the second half of 1969 and 1970. Additionally, with unemployment at this level, the Fed has rarely cut interest rates. Central bankers have said in recent days, including several times on Tuesday, that they see inflation moving in the right direction but are not yet confident enough to start cutting.
According to the Fed’s preferred barometer, inflation was 2.7% in April, or 2.8% if one excludes food energy prices, the core asset on which policymakers are particularly focused. The Fed targets inflation at 2%.
“Inflation has fallen sharply. It’s not where you want it to be, but it’s pointing in the right direction. Unemployment is pointing in the wrong direction,” said Sahm. “If you balance these two factors, 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.”
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2024-06-18 20:17:47
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