The Sahm Rule is near triggering … will September bring a rate cut? … climbing long-term inflation expectations … last call for tonight’s event with Tom Gentile
Last Friday, the June reading for the U.S. unemployment rate came in at 4.1%, up from 4.0% in May.
Historically, this remains a relatively low figure. However, the succession of higher unemployment readings over the last many months appears poised to trigger a very reliable recession indicator – the Sahm Rule.
Named after Claudia Sahm, former Federal Reserve economist and the originator of the indicator, the “Sahm Rule” compares the latest three-month average of the unemployment rate with the lowest three-month average over the past year.
When the latest three-month average is 0.5 percentage points higher than the lowest three-month average, the Sahm Rule triggers, suggesting the beginning of a new recession.
Since 1950, there has only one false positive (in 1959). But even in that case, the U.S. entered a recession six months later. The indicator correctly flagged the other 11 recessions.
After Friday’s unemployment report, the Sahm Rule reading climbed to 0.43
While less than the 0.50 line in the sand, this level is clearly knocking on the door. It’s also high enough for Sahm herself to express her dismay about the Fed’s apparent lack of concern.
This comes from Sahm back in March – well before the most recent uptick in her indicator’s reading:
They are taking risks that I have a hard time wrapping my head around…
The labor market’s bottom [won’t] fall out all of a sudden. But if the bad momentum gets going and you wait to see it clearly in the data, you’ve probably waited too long. Because once that snowball gets going downhill, nobody can stop it.
Below, we look at a chart of the Sahm Rule Indicator since 2000. The gray bars show recessions.
Note how the Sahm Rule line (in blue) begins spiking right at the beginning of each recession. Also pay attention to the lift-off we’ve seen in recent months (circled in blue) …
Is the snowball starting to roll downhill, to borrow Sahm’s reference?
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To what extent might this accelerate the Fed’s timing as it considers cutting rates?
Last week, speaking at a panel discussion at the European Central Bank (ECB) Forum on Central Banking, Federal Reserve Chairman Jerome Powell said:
We’d also like to see the labor market remain strong. We’ve said that if we saw the labor market unexpectedly weakening, that is also something that could call for a reaction.
An important question is whether the climb to 4.1% unemployment represents “unexpected weakening” that calls for a reaction.
Here’s Powell speaking after the June Fed meeting:
Overall, a broad set of indicators suggests that conditions in the labor market have returned to about where they stood on the eve of the pandemic—relatively tight but not overheated.
FOMC participants expect labor market strength to continue. The median unemployment rate projection in the SEP is 4.0 percent at the end of this year and 4.2 percent at the end of next year.
For the unemployment rate to end this year at 4.0%, it must fall from here. While going from 4.1% back to 4.0% isn’t a big move, the economic data we’re seeing all point toward weakness, which is indicative of higher unemployment, not lower. And last time I checked, snowballs barreling down a hill don’t usually reverse course and begin climbing back up that hill.
For the latest on this economic weakness, let’s go to our hypergrowth expert Luke Lango. From last week’s Daily Notes in Innovation Investor:
The ADP Employment Report showed that job growth in June slowed more than expected from an already-weak mark in May.
The Challenger Job Cuts report showed that job cuts spiked last month. Initial jobless claims rose more than expected [last] week. Continuing jobless claims spiked to their highest level since late 2021.
The ISM Services Index plunged far more than expected in June, with the New Orders index collapsing to its lowest level since December 2022 (and, before that, the depths of the Covid pandemic in early 2020).
The economy is clearly weakening, led by job market deterioration.
So, we have the economy weakening, suggesting that unemployment’s natural trajectory is higher rather than lower…
Yet, we have Fed officials penciling in a lower unemployment rate by the end of the year…
How do we resolve this apparent inconsistency?
Wall Street’s answer is simple – rate cuts
The CME Group’s FedWatch Tool shows us the probabilities that traders are assigning to various target interest-rate ranges at upcoming FOMC meetings.
As you can see below, the current odds of at least one quarter-point rate cut by at the Fed’s September meeting are 77.1%.
Now, keep in mind how shockingly wrong these projections have been all year.
Below we look at what traders believed would be the Fed’s interest rate policy at the start of the year (in blue) compared with its actual path plus the latest expectation (in orange).
Source: Creative Planning / @CharlieBilello
So, while the Fed might cut in September, just because Wall Steet is expecting it to happen means nothing. In fact, this majority expectation presents a heightened risk…
Wall Street’s 77% conviction that we’re standing on the verge of rate cuts means that the prevailing market “surprise” is bearish not bullish. So, if the Fed holds rates steady in September, then Wall Street is in for a major self-pity sell-off.
Given Wall Street’s near-perfect record of being wrong all year about interest rate cuts, we should at least consider they’re wrong yet again.
But where’s the blind spot, exactly? After all, inflation has been dropping, or at least, no longer climbing. Powell himself has said as much.
Well, last week brought one data point that could be a blind spot…
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Long-term inflation expectations just moved the wrong direction – did anyone notice?
When you listen to Powell speak in his live press conferences, you might have picked up on a phrase he often uses – inflation expectations remain “well anchored.”
For example, here’s Powell after the Fed’s May meeting:
We remain committed to bringing inflation back down to our 2 percent goal and to keeping longer-term inflation expectations well anchored.
This “anchoring” of expectations is critical because inflation has a huge psychological component. If consumers become convinced that inflation will worsen, they’ll buy goods and services today at prices that they believe will be lower than prices tomorrow.
Of course, it’s this very buying pressure that results in higher demand, fueling price increases. It’s a self-reinforcing feedback loop.
With this in mind, let’s go to The Kobeissi Letter from last week:
BREAKING: US consumers’ average 5-10 year inflation expectations have spiked to 5.6%, the highest in 31 years.
This measure increased by ~2 percentage points in just a few months.
By comparison, median inflation expectations are around 3%, in-line with the readings seen over the last 3 years.
Meanwhile, CPI inflation has been above 3% for 38 consecutive months, the longest streak since the 1990s.
Inflation is still a major issue.
Source: The Kobeissi Letter / Bloomberg
The data came from the University of Michigan in its survey on inflation expectations. According to the survey, these long-term inflation expectations have climbed from 4.6% in April, to 5.0% in May, to 5.6% in June.
So, what is the Fed watching more today? Weakening economic data that support rate cuts, or rising expectations of long-term inflation that support delaying rate cuts?
When you listen to Powell and the various Fed members, you get the feeling that they’re itching to cut if the data will give them a defensible argument. So, despite our belief that we’re a bit too sanguine about having defeated inflation, we suspect that the Fed will give the market at least one rate cut this year.
This belief was reinforced earlier today when Powell spoke on Capitol Hill, saying:
In light of the progress made both in lowering inflation and in cooling the labor market over the past two years, elevated inflation is not the only risk we face.
Reducing policy restraint too late or too little could unduly weaken economic activity and employment.
That certainly sounds like the Fed Chair laying the groundwork for a rate cut to me.
Here’s Luke’s take:
With the labor market weakening, inflation flatlining right around its long-term average should be enough to compel the Fed to begin their rate-cutting campaign this summer, either in July or September.
Those rate-cuts will reinvigorate the currently hobbled U.S. economy. We expect clarity to those rate-cuts – and, by extension, clarity to strengthen economic growth – to improve throughout July. As it does, that should boost stocks.
Thursday brings the latest Consumer Price Index data. We’ll be watching closely to see how the numbers come in, and what they might mean for the Fed and this long-awaited rate cut.
Before we sign off, a reminder that legendary trader Tom Gentile is going live tonight at 8 PM Eastern
Tom is a veteran trader who identifies reliable stock price patterns in historical data, then places calculated wagers that those patterns will repeat.
It can be an incredibly lucrative approach – in fact, it’s generated millions of dollars for Tom over his multi-decade trading career.
One of the most reliable patterns that Tom tracks is now flashing red for a handful of beloved AI stocks. There’s a good chance you own at least one or two of them in your own portfolio.
From Tom:
Something huge is headed for Nvidia and the biggest AI stocks in the market.
Thanks to one of history’s most consistent market patterns, anyone holding these stocks could lose their shirts…
The biggest names are headed for a crash in the same way the trendiest internet stocks did more than two decades ago. And those who aren’t prepared could get wiped out…
But that “wipe out” isn’t on our doorstep yet. And Tom believes the biggest fireworks in this AI bull market remain just ahead. Tonight at 8 PM, he’ll be discussing how to take part in this blow-off top, and then sidestep the eventual fallout (click here to instantly reserve your seat).
As I noted in yesterday’s Digest, given Tom’s decades of market experience, combined with the accuracy of his pattern-based trading approach, I’d encourage you to tune in tonight purely to listen to why he’s concerned. If you’re an AI investor, you want to be prepared.
