WASHINGTON — A surprising rise in the U.S. unemployment rate last month rattled financial markets and sparked renewed concerns about a looming recession — but it could also turn out to be a false alarm.
Friday’s jobs report, which also showed hiring slowed last month, coincides with other signs of a slowing economy amid high prices and high interest rates. A survey of manufacturing businesses showed activity weakened significantly in July. However, Hurricane Beryl hit Texas during the same week the government compiles its employment data and may have dampened job gains.
The U.S. economy used to give reliable signals when it was in or near a recession. But those signals have gone out since the COVID-19 pandemic hit and upended normal economic activity. Over the past two or three years, they signaled downturns that never came, as the economy continued to run at full tilt.
Fears of a recession are also quickly becoming politicized, especially as the presidential election heats up. On Friday, former President Donald Trump’s campaign said the jobs report was “further 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 added nearly 16 million jobs, while the unemployment rate has fallen to its lowest level in half a century. Some of those job gains reflect a rebound from the pandemic, but the U.S. now has 6.4 million more jobs than it did before the COVID-19 pandemic.
Still, Friday’s report from the U.S. Department of Labor has rekindled fears of a recession. The Dow Jones Industrial Average fell more than 600 points, or 1.5 percent, Friday, and the S&P 500 index fell nearly 2 percent.
Markets probably panicked in part because when unemployment jumped to 4.3% last month — the highest level since October 2021 — it triggered what’s known as the Sahm rule.
The rule, named after former Fed economist Claudia Sahm, states that a recession is almost always already underway if the three-month average unemployment rate rises by half a percentage point from its lowest level a year earlier. It has been triggered during every U.S. recession since 1970.
But Sahm herself doubts a recession is “imminent.” Speaking before the figures were released on Friday, she said: “If the Sahm rule were to be applied, it would join the ever-growing group of indicators, rules of thumb, that are not up to the task.”
Other previously reliable recession indicators that have failed in the post-pandemic era include:
- A bond market measure with a label as dry as dust: the “inverted yield curve.”
- The rule of thumb is that two consecutive quarters of declining economic output equals 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 bond yields, have not held up in recent years.
“This pandemic has been a time of a lot of apparent rule-breaking,” Powell said at a news conference. “A lot of the conventional wisdom just hasn’t worked, and that’s because it’s such an unusual or unique situation.”
Powell spoke after Fed officials kept their key interest rate unchanged but indicated 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 happen,” he said.
For four years, economists have been trying to understand how an economy that was paralyzed by the COVID-19 pandemic and then roared back to life, rekindling inflationary pressures that had lain dormant for four decades, works. When the Federal Reserve decided to tame rising prices by sharply raising interest rates starting in March 2022, economists almost universally predicted that rising borrowing costs would trigger a recession. But it never happened.
Post-pandemic trends in the U.S. labor market may have, at least temporarily, undermined the power of the Sahm rule.
Unemployment has been rising, not so much because companies are cutting jobs, but because so many people have flooded into the labor market. Not all of them have found jobs right away. The new arrivals are overwhelmingly immigrants, many of whom entered the country illegally. They are less likely to respond to the Labor Department’s employment surveys and so may not be counted as employed.
The yield curve inversion is also considered a signal of recession, as a recession is expected to occur when the Fed quickly raises its benchmark interest rate, which it has raised 11 times in 2022 and 2023. An inverted yield curve occurs when the interest rate on short-term Treasury bonds, such as two-year notes, exceeds the rate on a longer-term bond, such as a 10-year Treasury note. The shift occurred in July 2022, and yields have been inverted ever since, the longest such inversion on record.
Typically, long-term bonds have higher yields to reward investors who have locked up their money for an extended period of time. When short-term bonds start to offer higher yields, it’s usually because markets expect the Fed to raise its short-term rate to curb inflation or slow the economy. Such moves often lead to a recession.
According to Deutsche Bank, each of the last ten recessions has been preceded by about a year or two by an inversion of the yield curve. However, it gave a false signal in 1967, when an inversion occurred but no slowdown followed.
Why hasn’t it been good, so far, this time?
David Kelly, chief global strategist at JP Morgan Asset Management, says that historically, the yield curve inverts in part because long-term yields fall in anticipation of a Fed rate cut once the economy enters a recession.
Still, investors expect the Fed to cut rates because inflation is falling, Kelly said, not in anticipation of an economic slowdown.
“The perception of why the Fed might cut rates in the short term is quite different from the past, and that’s why the yield curve is not as worrisome as it has been in previous episodes,” Kelly said.
Tiffany Wilding, an economist and CEO of bond giant PIMCO, believes that the government’s massive financial aid programs, totaling about $5 trillion in 2020 and 2021, have made consumers and businesses richer. As a result, they have been able to spend and invest without borrowing as much, blunting the impact of the Fed’s rate hikes and dampening the signal that the yield curve is inverting.
Also in 2022, the government announced that gross domestic product (the economy’s output of goods and services) had fallen for two consecutive quarters, a long-standing rule of thumb that almost always accompanies a recession. Then-House Speaker Kevin McCarthy, a Republican from California, declared the U.S. economy in recession that month. He turned out to be wrong.
True, the headline economic data showed that output was falling. But another measure of GDP revealed a very different story: Stripping out volatile items such as 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 signal a broader slowdown. Still, consumers, especially those with higher incomes, are still increasing their spending, and 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 at T. Rowe Price’s fixed-income division. “I still don’t think the U.S. economy is headed for a hard landing.”
Associated Press writer Josh Boak contributed to this report.
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