US jobless rate rise triggers Sahm Rule, causing market turmoil and revising economic forecasts
The Sahm Rule, named after former Federal Reserve official Claudia Sahm, indicates a recession if the unemployment rate’s three-month moving average rises by half a percentage point from its low of the past year.
According to Financial Post, this threshold was crossed on Friday, changing the economic outlook significantly.
The US jobless rate jumped to 4.3 percent, leading to a swift and severe market reaction. On Monday, while Canadian markets were closed for the holiday, the S&P 500 dropped three percent, its worst day in nearly two years. Wall Street’s “fear gauge,” the VIX index, spiked to a record high.
Although futures climbed the next morning as investors sought bargains, analysts warned the relief might be short-lived. Previously, markets expected a soft landing, but now investors fear the Federal Reserve delayed cutting interest rates for too long.
On Friday, the US 10-year yield plunged 9.8 percent from the previous week. Such a drop has only occurred three times since 1962, each during significant financial crises, noted MortgageLogic.news analyst Robert McLister.
Markets now anticipate a strong chance of 1.25 percentage points in Fed rate cuts this year, a drastic change from near-zero expectations a week earlier. At one point on Monday, there was a 60 percent chance of an emergency cut within the next week, according to Bloomberg.
This development affects Canada as well, leading economists to revise their forecasts. Douglas Porter, chief economist at BMO Capital Markets, suggested that with the Fed likely to act more forcefully, the Bank of Canada might also accelerate its rate cuts.
BMO now expects cuts at each of the next four meetings, reducing the rate to 3.5 percent by January and possibly concluding at 3 percent by mid-2025, earlier than previously expected.
Despite market fears, Claudia Sahm expressed skepticism about an imminent recession.
“We are not in a recession now — contrary to the historical signal from the Sahm rule — but the momentum is in that direction,” she told CNBC. “A recession is not inevitable, and there is substantial scope to reduce interest rates.”
Historically, after the Sahm Rule was triggered, equities performed poorly, while safe havens like gold and the US dollar rose, and commodities struggled, according to the National Bank of Canada. It noted that in previous instances, the Fed usually lowered interest rates before the Sahm Rule was triggered.
Canadian economist Harold Innis once described the country as “hewers of wood and drawers of water.” Recent data supports this, with the natural resources sector accounting for almost 13 percent of nominal gross domestic product in 2022, the largest share since 2014, according to Statistics Canada.
Alberta contributed 38 percent of this, with 94 percent coming from the energy sector. Natural resource exports rose 34 percent that year, driven by post-pandemic demand and price surges. Energy exports increased by 53 percent, minerals and mining by 18 percent, and forestry by 14.5 percent.
