What is the “contribution rule” that raises market fears of a US recession? | Economy

Global stock markets have been in a sharp decline since last week, after a disappointing US jobs report triggered the “contribution rule”, a usually reliable indicator of economic recession.

What is the “contribution rule”?

The Sahm Rule was created by Claudia Sahm, a former economist at the US Federal Reserve and the White House.

This rule states that the US economy enters a recession when the 3-month average unemployment rate is 0.5% (50 basis points) or more above its lowest level in the previous 12 months.

This “purely empirical” indicator, which lacks a “theoretical basis”, as Florian Elbow, head of macroeconomic research at Lombard Odier IM, recalls, reached 0.53% in July 2024.

The expert explains that since the US unemployment report was published on Friday, which rose more than expected to 4.3%, the highest unemployment rate since October 2021, markets have “clearly concluded that we will witness a recession” and are plunging into the red.

No recession according to Claudia Sahm

Despite these numbers, economist Claudia Sahm herself doubts the applicability of her indicator this time, saying in an interview with Fortune magazine published Friday: “I don’t think we are currently in a recession.”

“No one should panic now, even if it seems that way to some,” she added, because there are leading indicators for the economy that “still look very good.”

Sahm noted that household income continues to grow, while consumption and business investment remain resilient, adding: “This time could be really different.”

The research group Capital Economics noted that the rise in the unemployment rate had so far been driven by an increase in the workforce rather than a decline in employment.

“This is a departure from previous cycles,” Neil Shearing, the group’s chief economist, said in a note, adding that “Hurricane Beryl likely contributed to the weak payrolls figures in July.”

US Federal Reserve Chairman Jerome Powell also sought to reassure investors, saying at a news conference on Wednesday that the SAHM rule is a “statistical regularity” and “not an economic rule that says something is going to happen.”

The Federal Reserve decided on Wednesday to keep interest rates at their highest level in 20 years, while indicating the possibility of cutting them next September.

Any impact on interest rates?

Recession fears have increased pressure on the Federal Reserve to cut interest rates more than expected, or even before its next meeting.

Jerome Powell made his remarks before the unemployment figures were released.

“This is clearly something that the Fed will be concerned about,” Florian Elbow said.

“Is it possible for the Fed to cut interest rates unplanned? At the moment, that is unlikely to happen,” the economist said.

Some analysts expect the Federal Reserve to cut interest rates by 0.5% in September, a higher amount than previously expected (0.25%).

Elbow estimates that the Fed may make such a cut “to slow the market downturn, if it really continues until then.”

Deutsche Bank said markets were now pricing in a 2 percentage point cut over the next 12 months, “something we have only seen in a recession before.”

But Shearing, an economist at Capital Economics, expects the Fed to cut by 0.25% at each of its three remaining meetings this year.