Is the US Heading into Recession?

Weak numbers on the US labour market have led to widespread fears that the US is heading into recession and, although certainly not the only reason, been followed by a slump in equity markets around the world, especially in Japan. Bond markets have rallied hard. We evaluate recession risks in the US and attempt to draw some conclusions for the outlook for markets.

The key element in last week’s US labour market data that led to heightened recession fears was the triggering of the Sahm Rule¹, named after an economist at the Federal Reserve (now working at Bloomberg). She noted that a rise of 0.5 percentage points in the three-month moving average of the US unemployment rate compared with its low over the previous12 months signals a recession. This rule has given no false positives and no false negatives in the 11 recessions since 1950. It is also accurate in terms of timing within a few months. And much more accurate than standard measures such as the yield curve.

It is therefore certainly something to be concerned about. The first point to note is that the timing of US recessions is determined by a committee of economists at the National Bureau of Economic Research. They look for a widespread downturn across the economy that lasts for a more than a few months. We are clearly not there yet. Taking a step back, there is little evidence of the financial imbalances that typically presage a recession. Both personal and corporate balance sheets are in good shape. I do expect a slowdown in the US as the consumer retrenches but this would be a modest pullback, not a recession. There are also concerns about the unemployment numbers themselves. Much of the rise reflects a huge jump in those out of work due to bad weather or temporary layoffs and this should quickly reverse.  The massive influx of unauthorised immigrants to the US, who are typically eligible to work after a few months but have a higher unemployment rate, is also a factor. In addition, the data comes from a household survey which has seen declining response rates. This makes the numbers less accurate. This drop in response rates has also occurred in the UK on a bigger scale and has led our statistics agency to ditch the survey. Finally, the inventor of the rule, Claudia Sahm, says she doesn’t think a recession is upon us.

We are reluctant to say ‘it’s different this time’ when a rule has worked so well in the past. The data might take a broader and deeper step down. But our best guess is that it’s a false alarm.

So, what does all this mean? Firstly, the big market moves were not all due to the weak US data. The unwinding of the huge yen carry trade means thar the biggest moves have been in Japan and these moves are often exaggerated when they occur in August. If we are right and the US slowdown does not turn in recession, we can expect markets to stabilise and recover. There may be a more enduring effect on the US Federal Reserve who have come in for much criticism and are likely to cut interest rates rather faster than they might have done previously. This would therefore be a buying opportunity of equites and an opportunity to take profits on bonds.