WASHINGTON — A surprising increase in the unemployment rate in the US last month has shocked financial markets and renewed concerns about the threat of a recession. But it could also prove to be a false alarm.
Friday’s jobs report, which also showed employment slowed last month, comes amid other signs the economy is cooling amid high prices and increased interest rates. A survey of manufacturing firms showed activity slowed noticeably in July. But Hurricane Beryl hit Texas the same week the government collects its jobs data and may have held back job growth.
The U.S. economy used to give reliable signals when it was in a recession or near recession. But those red lights have been out of whack since the COVID-19 pandemic hit and upended normal business activity. Over the past two or three years, they’ve signaled downturns that never came because the economy just kept rolling along.
Concerns about a recession are also quickly becoming politicized, even more so as the presidential election heats up. Former President Donald Trump’s campaign said Friday that the jobs report is “more evidence that the Biden-Harris economy is failing Americans.”
For his part, President Joe Biden said that since he and Vice President Kamala Harris took office, the economy has created nearly 16 million jobs, while the unemployment rate has fallen to a half-century low. Some of that job growth reflects a recovery from the pandemic, but the U.S. now has 6.4 million more jobs than it did before COVID-19.
Still, Friday’s report from the U.S. Department of Labor has renewed recession fears. The Dow Jones Industrial Average fell more than 700 points, nearly 2%, on Friday afternoon, and the broader S&P500 fell 2%.
Markets likely panicked in part because unemployment rose to 4.3% last month, the highest level since October 2021, triggering the so-called Sahm rule.
The rule, named after former Fed economist Claudia Sahm, states that a recession is almost always declared when the average three-month unemployment rate rises by half a percentage point from last year’s low. The rule has been triggered in every U.S. recession since 1970.
But Sahm herself doubts that a recession is “imminent.” Before the numbers were released Friday, she said, “If the Sahm rule were to take effect, it would join the growing group of indicators and rules of thumb that have failed to live up to the task.”
Other previously reliable recession indicators that have flopped in the post-pandemic era include:
— A bond market benchmark with a dry as dust label: the “inverted yield curve.”
— The rule of thumb that two consecutive quarters of declining economic output amounts to a “technical recession.”
On Wednesday, Federal Reserve Chairman Jerome Powell said he was aware of the Sahm rule and its implications, but noted that other recession signals, such as changes in Treasury yields, have not been confirmed in recent years.
“This pandemic era is one in which so many apparent rules have been broken,” Powell said at a news conference. “A lot of received bits of received wisdom just haven’t worked, and that’s because the situation is really unusual or unique.”
Powell made the comments after Fed officials left their key interest rate unchanged but signaled they could cut the rate as early as their next meeting in September.
Powell also downplayed the impact of the Sahm rule, calling it a “statistical regularity.”
“It’s not like an economic rule that tells you something has to be done,” he said.
Economists have struggled for four years to make sense of an economy that was first shut down by the COVID-19 pandemic, only to rebound so strongly that it reignited inflationary pressures that had lain dormant for four decades. When the Federal Reserve attempted to curb price increases by aggressively raising interest rates starting in March 2022, economists nearly unanimously predicted that the higher borrowing costs would trigger a recession. It never came.
Post-pandemic trends in the U.S. labor market may have temporarily made the Sahm Rule less effective.
Unemployment has been rising steadily, not so much because companies are cutting jobs, but because so many people have entered the labor market. Not everyone has found work right away. The newcomers are dominated by immigrants —many of whom entered the country illegally. They are less likely to respond to labor investigations by the Ministry of Labor and are therefore not counted as workers.
The inverted yield curve, meanwhile, is also seen as a recession signal, as a recession is expected to occur if the Fed quickly raises its key interest rate, which it raised 11 times in 2022 and 2023. inverted yield curve occurs when the yield on a short-term government bond, such as a two-year bond, rises above the yield on a long-term government bond, such as a 10-year government bond. The switch occurred in July 2022, and since then yields have reversed, the longest inversion on record.
Normally, longer-term bonds pay higher yields to compensate investors for tying up their money for a longer period. When shorter-term bonds start paying higher yields instead, it’s usually because markets expect the Fed to raise short-term interest rates to suppress inflation or cool the economy. Such moves often lead to a recession.
An inverted yield curve has preceded each of the last 10 recessions, usually by about one to two years, according to Deutsche Bank. It did give one false signal in 1967, when an inversion occurred but no downturn followed.
Why hasn’t it gone well this time so far?
According to David Kelly, Chief Global Strategist at JP Morgan Asset Management, the yield curve historically inverts partly because long-term interest rates fall when the Fed is expected to cut rates once the economy enters a recession.
Still, investors expect the Fed to cut rates because inflation is falling, Kelly said, not because they expect a downturn.
“The perception of why the Federal Reserve would cut rates right now is very different than it has been in the past, and that’s why the yield curve isn’t nearly as ominous as it has been in previous episodes,” Kelly said.
And Tiffany Wilding, an economist and managing director at bond giant PIMCO, says the massive government stimulus packages, which totaled about $5 trillion in 2020 and 2021, enriched both consumers and businesses. As a result, they were able to spend and invest without borrowing as much, muting the impact of the Fed’s rate hikes and blunting the inverted yield curve signal.
Also in 2022, the government reported that gross domestic product (the economy’s output of goods and services) had fallen for two straight quarters, a long-standing rule of thumb that almost always accompanies a recession. Then-House Speaker Kevin McCarthy, R-Calif., said the U.S. economy was that month was in a recession. It turns out he was wrong.
It’s true that the headline economic figures showed output falling. But another measure in the GDP report told a different story: When you strip out volatile items like inventories, government spending and imports, the underlying economy continued to grow at a healthy pace.
Economists worry that last month’s rise in the unemployment rate could be a harbinger of a broader slowdown. Still, consumers, especially higher-income consumers, are still increase their spendingand as long as layoffs remain low, they will likely continue to do so.
“I don’t think the U.S. economy has fallen out of bed,” said Blerina Uruci, chief U.S. economist for T. Rowe Price’s fixed income division. “I still don’t think the U.S. economy is headed for a hard landing.”
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Associated Press reporter Josh Boak contributed to this report.