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Cooling, not contracting: Claudia Sahm explains why the Sahm rule flagged a false recession

This week I had the pleasure of speaking with economist Claudia Sahm, who developed the recession indicating “Sahm rule” in 2019. 

The Sahm rule states: When the three-month moving average of the national unemployment rate is 0.5 percentage points or more relative to the minimum of the three-month averages from the previous 12 months, the economy has hit a recession point.

When using it to evaluate the economy back to the 1970s, the Sahm rule has been a reliable, even “perfect” indicator, but recently, it’s thrown up a rare false positive.

So why was this time different?

Post-pandemic disruptions, unusual labor dynamics, and a huge wave of immigration are all complicating factors. Claudia says that when immigrants and those who left their jobs early in the pandemic came back into the market, that quickly grew the denominator of people who were unemployed and looking for work, therefore giving the unemployment rate a big jump. 

These changes were enough to make the Sahm rule indicate a recession—but they didn’t necessarily spell a downturn for the economy.

Claudia says that this time around the Sahm Rule caught signs of cooling, not contraction: The labor market has softened some—it’s harder for new grads to find employment. But at the same time, we are not seeing layoffs at the same levels we have seen in the past. 

The labor market’s not good if you’re looking for work, but it's pretty good if you have a job, she says.

New job creation is slowing, which adds pressure to the labor market overall. However, in this case, this is not the definitive indicator of recession as other indicators like GDP and demand, continued to show growth.

“This period has been extremely complicated, and our simple rules of thumb have really not been up to the task,” Fed expert Claudia Sahm told me this week. 

Looking forward, Claudia predicts only 100 more basis points cut in this rate cut cycle. 25-basis-point cut in November, December, February, and March. Her forecast signals a more cautious approach, contrasting with others who believe rates might need to be cut more aggressively.

I highly suggest listening to my full conversation with Claudia as we dive into all of the complicated aspects of today’s markets and our thoughts on how the Fed has and will respond to these complications. 

ResiClub chart of the week: 

This week, ResiClub’s Lance Lambert reported that eight U.S. states are now back above pre-pandemic inventory levels.

In August 2024, only four states had reached or exceeded their active inventory levels from 2019. By September, this grew to seven states, and in October, it increased again to eight: Arizona, Colorado, Florida, Idaho, Oklahoma, Tennessee, Texas, and Utah.

Alabama, Oregon, and Washington may soon join this list.

Why does this matter?

“Generally speaking, local housing markets where active inventory has returned to pre-pandemic levels have experienced softer home price growth (or outright price declines) over the past 24 months,” Lance wrote.

“Conversely, local housing markets where active inventory remains far below pre-pandemic levels have, generally speaking, experienced stronger home price growth over the past 24 months.”

Number of the week: 4.1%

According to Claudia, the most important number for you to watch is the unemployment rate. For September, the unemployment rate is 4.1%.

I personally think it's better to keep an eye on unemployment claims, which is a weekly tracking number, but she disagrees. 

While it’s good to see how things are shifting, Claudia says looking at week-by-week changes too closely, you can lose sight of what’s going on overall in the labor market. In general, for the average person, monitoring the momentum or rate of change is a more meaningful indicator than week-by-week changes.

Register for ResiDay

I want to remind my readers I’ll be speaking at the first-ever ResiDay, hosted by Lance Lambert’s ResiClub, in New York City on Friday, November 8th. That’s one week away.

There will be hundreds of influential housing single-family landlords, developers, lenders, and brokers who are shaping the future of residential real estate, homebuilding, mortgage lending, and build-to-rent. Several prominent real estate journalists will also be there.

The ResiDay discussion will center around where the U.S. housing market is now and where it will go from here.

Expect great conversation, networking opportunities, and just plain fun—I hope to see you there.

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