Odd Lots - Lots More With Claudia Sahm on What the Sahm Rule Is Saying Now

Episode Date: August 16, 2024

The Federal Reserve appears to be ready to pivot into rate cutting mode. Inflation has come down significantly, and the unemployment rate has been trending upward for most of the year. In fact, in the most recent Non-Farm Payrolls report, the headline unemployment rate of 4.3% triggered the so-called "Sahm Rule," which has been a historically reliable signal that the US is already in a recession. So are we in a recession? Could the rule be wrong this time due the unique features of this economic cycle? How should the Fed weigh the risks that we see in front of us? On this episode of Lots More, we speak with the rule's creator, Clauda Sahm, Bloomberg Opinion contributor and the chief economist at New Century Advisors. She explains why the signal this time could be misleading, but also why — regardless of whether we're in a recession or not — the Fed must be on guard for a weakening labor market.Read More: My Recession Rule Was Meant to Be BrokenWhat’s the Sahm Rule? Is It Warning of a Recession?Only Bloomberg.com subscribers can get the Odd Lots newsletter in their inbox each week, plus unlimited access to the site and app. Subscribe at  bloomberg.com/subscriptions/oddlotsSee omnystudio.com/listener for privacy information.

Hello, I'm Michelle Hussein, and for more than 20 years, I was at the BBC. But all the time I was delivering the headlines, I wanted to go further than the news of the day, to spend more time with the people shaping our world. And that's what I'm doing here on this podcast, speaking to people from Nigel Farage. To love you trying ever so hard. To tech journalist Karaswisha. And the tech industry is running wild. You know, they've gotten what they wanted

and they've seen a huge run-up in their stock prices. This will be a place where every weekend, you can count on one essential conversation to help make sense of the world. So please join me, listen and subscribe to the Michelle Hussein show from Bloomberg Weekend, wherever you get your podcast. You certainly ask interesting questions.

Bloomberg Audio Studios. Podcasts, Radio News. Hi, Claudia. Hello. How are you doing? Good. How are you doing? Pretty good.

It's a little calmer this week, so no. Oh, yeah. Last week was a little nuts. Last week was nuts. Oh, my gosh. Yeah. So good to catch breath. Sometimes I wonder if you have a Google alert set up for SOM and if it's just like going off constantly in the past 10 days.

There were several hits of my Google alerts the last couple. I don't have one on the side. I think that probably would have been even more out of control. I did a deadlift. One, two, three. Hedge. Okay, go. What's...

GEMany. Barges. This is an after-school special, except... I've decided I'm going to base my entire personality going forward on campaigning for a strategic pork reserve in the U.S. Where's the best squid in Pustin? These are the important questions. Is it robots taking over the world? No, I think that like in a couple of years, the AI will do a really good job of making the outlots punch.

and people are saying, I don't really need to listen to Joe and Tracy anymore. We do have... Cha-ching? The perfect guest. You're listening to Lots More, where we catch up with friends about what's going on right now. Because even when the Odd Lots is over, there's always lots more. And we really do have the perfect guest. We are speaking with Claudia Somm, of course, the creator of the SOM rules.

She is chief economist and New Century Advisors and also a columnist at Blue. And you've been in the news a lot recently, Claudia, because actually, I can't figure this out. Has your rule actually triggered or not? It has the way that I calculated the SOM rule. And it was very close to the trigger. So the value in July is 0.53. And the threshold is 0.5 or above. And there have been people doing various calculations of the same principle of change.

in the unemployment rate relative to the past 12 months. And you can get very small differences depending on how you do it. I think that just says, I mean, it's right at the edge, but the official SOM rule is triggered. And every time I write about the SOM rule, I'm always like only 99% sure or 90% sure I remember what it is and I always go look it up. But it's what it basically states is that when the three month moving average of the unemployment rate is 0.5% above the 12-month low, then historically in post-World War II recessions, every single time that has happened. Every time it's written above, gotten above half a percent, a recession came soon thereafter. Is that correct? Yeah, half a percent or more.

Half a percent or more, sure. Yeah, they can. And that's, and historically, and in particular, that very kind of precise record is in the data as it was published at the time. And time, right? So, exactly. Right. So right around. But in principle, yes. And, you know, the important things, you take the three month moving average, so you smooth out over time. You take that current three month average. Look at the low of the three month averages over the prior 12 months, not including the current, the prior. And those are the changes. But it all is, I think like the formula, the thresholds very much go back to the purpose of it, which was. was to create an indicator, a simple one to initiate fiscal relief. So like stimulus checks, extra jobless payments. So it needed to be something simple. And it needed to happen in the recession. So like the recession is already here.

The song rule is not a forecast. It typically has triggered about three months in to recessions historically. And it's not meant to get ahead of it. It was meant to. It's here. The unemployment rate has started to rise. We know in recessions, It continues to rise. A half a percentage point increase in unemployment rate is not a big deal.

This is not a worrisome feature in and of itself. It's where it tends to go from there that makes the recession is damaging. So this is important. So the origin of the rule is that you wanted something that was dependable that you could use as more or less immediate guidance for the government to actually come in and do something about recession. But because the rule is also encoded and calculated in a very specific way, so the U.S. is entering recession whenever unemployment is running 0.5 percentage points higher than the prior 12 months lows, because it's set in stone, it also cannot take into account, I guess, differences in the current economic environment or maybe nuances that are not necessarily captured by those hard numbers. Right. It's because again, the goal was looking back over history, what is the formula, the rule that would get to turn on fiscal relief, so stabilization, as early as possible in a recession, so it could do the most good and also be as accurate as possible. It is looking back over history. So in the United States, you can look back over several decades. I mean, looking across several different recessions, different kinds of features. And yet there have been, and this is a theme of this entire cycle since the pandemic began, some very unusual disruptions that the pandemic kicked off. And the Someril is now in a long list of our kind of macroeconomic tools that have fallen victim to features,

particularly supply, very abrupt supply shocks that just aren't there to the same extent. in the historical record. So that's where the pattern, it relies on a pattern. And the dynamic, that's really powerful. It's happened for post-World War II period. And yet it is not infallible and had an opportunity to talk about this for,

I found post from two years ago explaining why the Somerol might break. And certainly, like, this is where it's been headed. But that's instructive, too, about what's actually going on right now in the economy. And it is not to say that all is good with the labor market, even if the Somer rule says it's a recession and we do not have a recession, right? There is information here about the health of the labor market, some concerning signs in the labor market.

Right. So you developed this role in part to guide countercyclical fiscal fiscal policy. Right now, it's pretty clear that we're nowhere near any sort of political will. We're going to start sending checks again. So if there's going to be a response to the weakness, it's going to come on. The monetary policy side expectation is for some sort of rate cut in September. where when we got that last unemployment report and the SOM rule did technically trigger, there was a lot of debate.

Oh, is it different this time? This isn't really driven by layoffs. It's about the fact that there's a lot of entrance into the labor force and the hiring rate is slowed down, et cetera. I guess what I would start is, what is, from your perspective, okay, the rule is triggered? What is the case for sort of quibbling or people trying to explain away or, oh, the headline unemployment isn't quite that bad this time and oh layoffs are still pretty low that strikes me as a sort of risky line of dialogue but i'm curious your take yes so it is always risky to go down that this

time is different and there's a long historical record of explaining away bad news yeah that that ends up being actually it was bad news and that was your chance to see it so no i take this very yeah this is this is tough right it's been tough to think about what's wrong here and pull out the actual, like, what's the right message from the labor market? And it's nuanced. There's not a simple message. I push back pretty strongly on the idea of, oh, well, we haven't seen the layoffs. If you look, and some of this is, understand, like these measures, like the somer, these things where you're looking at these small changes on unemployment rate, these are features early in recessions. Recessions do have a, they turn on, right? It is actually a, the economy starts to contract. It's a subjective decision of the National Bureau of Economic Research experts on when we go into a recession and we come out. But there is a, the economy starts to contract. And the early phases of a recession, like the early six months, say, of a recession, often, 2020 was an exception, but often are a slow grind into it. Right. You can see the signs of the contraction, but the unemployment rate often,

usually peaks gets to its highest level after the economy has come out of the recession. Right. Right. So those layoffs, if you wait to see mass layoffs, you are typically well in to a recession, right? Again, COVID came just out of nowhere and so rapidly that if our mind is set on what COVID doesn't even look like a recession. Like it just, it just looks like a shock to our system, which it was. So this whole like, oh, we don't see it in the layoffs.

I don't buy that. I worry, one of the things that even when I push back on my own rule, this is saying it's not, it's overstating the weakness is one feature. I mean, we've seen right now that the, the firing rate is still very low, right? So from like the job opening labor turnover survey,

we're still very low levels. The hiring rate has come down. I mean, it had been very high, labor service has come down. And it's now at levels that are like 20, 14 levels, which wasn't a particularly good labor market. So you do have businesses who really got burned from mass layoffs under COVID, labor shortages, trying to hire back, all of this difficulty.

Now, they're holding on to workers. So what is that tell us employers to some extent have likely changed the way, like that pattern of how they adjust to their demand for workers, right? You can do it through and often hiring will show up much sooner in terms of it weakening. So I, it's the firing rate being very low right now. It doesn't give you much cover because the firing rate tends to go up as the recession proceeds. Like in no way, shape, or form am I arguing the recession started six, nine months ago, right? Like, that's not a relevant comparison. And then I think we have some evidence that that margin of holding on to workers versus hiring workers may have shifted some from the pandemic. So it's kind of like you get it.

It has to go all ways, right? If you have a pattern, if COVID has really disrupted a pattern in the labor market that works in favor of saying, oh, well, it's actually not as bad this time as it would normally look. Well, you've got to be careful that there aren't stories that unwind it just the other way. On April 4th, 2023, around 2 in the morning, a man was found stabbed multiple times on a sidewalk in downtown San Francisco. Hey, who did this to you? What happened next turned the story into a political firestorm. Reports have identified the victim as Bob Lee, the founder of Cash App. From Bloomberg Podcasts, this is Foundering, the Killing of Bob Lee, beginning April 16.

Joe, you've talked about this, right? The idea that in some ways unemployment can be exponential and can kind of start feeding on itself. Yeah, exactly. Yeah, and to Claudia, I mean, to your point, which is technically, I think the recession, the financial crisis recession ended like in the summer of 2009. The unemployment rate in that cycle, it actually technically peaked in the October 2009 report at 10%. So that was after, to your point, to your point, Claudia. So why would it be different this time? I mean, like, you see, there's this danger and yes, COVID mess with stuff, et cetera, but I just pulled up the hiring chart, the hiring rate. It's, you know, back in 2014 levels. Like, why shouldn't we take the signal that your rule says quite seriously? We should take the increase in the unemployment rate seriously in terms of the direction, right? It is rising. There is weakening demand for labor. Yes. And that that is, so, So like setting all of this aside about the summary recession, not a recession, like the direction we are on is a until it levels out is a problem. Okay.

Right. And we can talk about there are reasons. You know, the Federal Reserve has interest rates high because they are fighting inflation. It should not be a real surprise that the unemployment rate is drifting up. Right. Right. In that sense. So there's that aspect of we can chuck the som rule if you want to.

But it's like keep an eye on the unemployment rate and what it's doing and why. what's going on underneath it. And the piece that right now is this hustle, and this is the thing that the SOMR was too simple, too simplistic in trying to get at, is that separating out changes in unemployment, so unemployment rate rising because there's a weakening demand for labor. And that can show up in a lot of ways.

It doesn't just have to be layoffs. It can also be lack of hiring, right? So anything that's weakening demand of labor, that pushes up the unemployment rate, and that can be very pernicious because a worker without a paycheck or a smaller paycheck buys less. And then that business needs for your work. So that's the dynamic we're trying to shut off.

Okay, so that's a bad dynamic. That's clear. It's in there. And yet what's also in there this time is you have shifts in the supply of workers. So labor supply. And the Salmoral works, it looks at the changes in unemployment rate, which you have to do with the history. because we have gone into recessions at all different levels of unemployment.

Like a low level unemployment does not protect you from a recession. Right. It's about these dynamics. So when there are two things have happened with this, there are other indicators, I think, that are out there, look kind of labor market that are struggling with the same issue, is that early in the pandemic, we had a plunge in the labor force.

Millions of people just walk away from work. Okay. Some of them came back, but many didn't, you know, or retirements or other. Just we lost, and you'll see it a lot of times in beginning recessions, there's a decline in the labor force, right? There are patterns of labor supply back in history around recessions, and yet this, like, it's huge. And what then happened is when customers came back quickly, some of those workers did not come back or came back much more slowly, and we had labor shortages. The unemployment rate early in the recovery, when you get to the depths of like, 3.4% unemployment rate and you're in a labor shortage, one of the reasons that unemployment rate is

so low is because you have too few workers, right? It's pushed, like labor supply is pushing it down. So we've got like starting points that are probably pushed down because we've been missing workers. And then we get to a place that, you know, we've seen in the last few years, those labor shortages, amazingly, the labor shortages were addressed with more workers, not fewer customers, which is like the thing the Fed can get us, fewer customers, but it got more. workers and there's a portion, particularly this very big, abrupt change was in the immigration into the United States. And that's actually made it hard in our measurement even. Like, it's very hard for me to, with any conviction to quantify exactly how much of this labor supply effect,

because it's not just that there's increasing labor supply. We've had recessions, 1970s, had increases in labor force. We had entrance into the labor market contributing as the somrel triggered. But what we've had this time are just these big swings in one direction, the other direction. And so then when that piece is in there,

you get, now we have what looks like some of the increase in unemployment rate is coming from more labor supply. Over the interim, I mean, it's higher unemployment is always bad for the unemployment. person, right? Like, they're looking for a job. But when we look at that high unemployment and think about where it's headed, if it's coming primary from labor supply and it's, and especially

an abrupt, then it's more of a matching. Like, we need the jobs to catch up now. And as they catch up, well, then the unemployment rate will drift down or at least settle down. Right. And then once you're getting workers, when you get more workers into the economy, it's the exact opposite of a recession dynamic. It's an expansion dynamic because you've got more workers. You can make more. So you have like totally opposite, you know, is this increased unemployment rate a really bad sign? Is this increased unemployment rate a really good sign? Unfortunately, I think the best we can do right now is to say these two things are both in play and to watch them carefully. And that's where I think taking seriously the weakening part of the labor market, because there are policy levers to pull with

the Federal Reserve, can get those under control and then help that kind of catch-up process of jobs. Like the stronger the job market is, the faster we can bring in these workers. So this is kind of the other reason why your SOM Google Alert would have been going off like crazy over the past week or so is there's also like everything in the world nowadays, at least in the U.S., there seems to be this intense politicization of this particular economic rule and of the jobs market and of what the Fed should do. And I think like some of the irony of the current moment is you see accusations that the Fed is behind the curve. You see accusations that if it cuts in September before an election, that's because it's trying to support the Democrats and support Kamala Harris. And you've been kind of on

the receiving end of some of that commentary. What do you say to people who think this is all about politics and justifying downwards momentum in the labor market at a very politically sensitive time? So to be honest, I haven't tried to engage in that discussion because I didn't think, I mean, the solemn rule, it's a tool. This is a really important time to have a robust discussion about what's happening in the U.S. labor market from the vantage point of policymakers, more businesses, households. Right? So that it is timed with an election year.

That's unfortunate. But I had been aware, like realizing this dynamic before last week, you know, there had been, as an example, people had looked at these state-level changes in the unemployment rate, so like kind of state-som rules. And I've written about this also. Like there were some states like California that have had larger increased unemployment rate. And there were quite a few that had hit the half a percentage point. There is no state somerable, but, you know, using that trigger.

And I cert—and this was several months ago, like in the spring, writing about this. And I got a lot of pushback from some people that I wasn't being true to my rule because there was a Democrat in the White House. And I wasn't willing to say a recession. And, you know, for all this, it's like, I wouldn't wish a recession on anyone. Like, I don't care who's in the White House. But it is an election year, and I'm not that naive, and I understand that people, and recession is a very charged. I mean, it's a very bad experience, and it also has meaning beyond its actual definition. So I'm not surprised.

It's unfortunate, but, and I certainly, I mean, the thing with looking at these, these, I mean, it's called a rule, the summit, because it's a policy prescription, right? It's not a rule. We must have a recession. It's a, you know, it's supposed to be a prescription. of policy. And this is not creating panic or a concern where I think if you look broadly at economic conditions, like output, consumer spending, income, like the U.S. economy is not contracting. And even after we go through revisions, I think it's going to be hard to say July 24 was a recession. I just don't see that. I'm June Grosso, inviting you to join me for the Bloomberg Law podcast.

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On the East Coast, listen as you start your day. And on the West Coast, catch up in the evening. That's the Bloomberg Law podcast with me, June Grosso. Subscribe today wherever you get your podcast. This is my summary of your views and tell me if I'm wrong. There are reasons to think that unlike the... past times when the SOM rule has triggered, we may not be in a recession because other economic data looks good and much of the upward push in the unemployment rate is due to the influx of labor

supply. Yet on the other hand, there is this clear deceleration in demand for labor. And so regardless of the recession question or not, and the specific trigger in what it says, that from a sort of policy and risk management move, it's a good time for the Fed to essentially go. go in the other direction or essentially engage in stimulative policy one way or another. Yeah. At this point, they can just take their foot off the break a little bit. This isn't even – because, again, the – this is where when Fed policymakers or Fed Chair J. Powell, the last press conference before we got the July data, essentially saying we, the Fed don't want to see more weakness in the labor market, more weakening.

And it's like, well, you left rates. uncut, right? It's like, what do you think is going to happen? The direction here is really clear. And what I have a very hard time of without appealing to the Fed reducing interest rates, it's a hard story to tell as to what it is that levels it out. Right. What is it that helps stay at this place? And yeah, sorry. It creates the demand for labor. Yeah, or just, yeah, creates the demand levels out this weekend. I agree. The labor market was really firing on all cylinders, and labor shortages were very disruptive. So we were going to see job gains slow. We were going to see the unemployment rate drift up some.

But you're getting to a place now where, yeah, the level looks really pretty good. I mean, not really pre-pandemic good levels, but the direction is a problem. That's the piece, I think, has to have a focus in policymaker's mind. But then there is a very useful discussion about how much of that direction, that say the increase in unemployment rate, how much of that is coming from these good factors and from these more problematic ones. Claudia, did you see Ben Eamonds? He did a SOM role with initial jobless claims. Did you look at that? I am thrilled to have more into particular on this like we are in a recession indicators things I still think there's a long

there's a long way to go on a lot of work to do on say these semi-automatic stabilizers fiscal policy put on autopilot I think it's still worth pursuing it and it's clear like if this the somerle didn't work right there's something better out there so it is I think it is really helpful to look at other indicators at this point because the labor market has these features, right? Like, when I were talking about this problem of, like, there's this labor supply, and it's masking what we typically look at is the, like, labor demand that's with a cycle. I just, I don't think at this point we're going to get a clear signal just from the labor market.

Claims has some issues, vacancies have issues in similar ways. We'll find out one day in the long future what the NBER says was really going on in summer 2024. That's the great thing about the current economic moment is, like, we are actually going to learn a lot of things from it. Someone will be proven right, someone will be proven wrong, and then there will be a new set of debates to play it all over again. It will never end. Yeah.

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