Sam, the economist who set the rules for the recession, said the Fed was “playing with fire.” | Wilnesh News

Not cutting interest rates now could send the economy into contraction, according to the author of a time-tested rule for how recessions occur.

Economist Claudia Sahm said the economy enters a recession when the three-month average unemployment rate is half a percentage point above the 12-month low.

As unemployment has risen in recent months, Sam’s Rule has fueled growing talk on Wall Street that cracks are emerging in a traditionally strong labor market and portends potential trouble ahead. That, in turn, has fueled speculation about when the Fed will eventually begin cutting interest rates.

Sam said the Fed is taking a big risk by not taking action now to gradually cut interest rates: If it doesn’t take action, the Fed risks the Sam rule taking effect, and the ensuing economic downturn could force policy Framers took tougher action.

“My benchmark is not a recession,” Sam said. “But it’s a real risk and I don’t understand why the Fed is taking that risk. I’m not sure what they’re waiting for.”

“The worst outcome right now is that the Fed triggers an unnecessary recession,” she added.

As a digital readout, Sam’s rule is 0.37 Previously, the May employment report released by the U.S. Bureau of Labor Statistics showed that the unemployment rate rose to 4% for the first time since January 2022.

This number essentially represents the percentage point difference between the three-month unemployment rate average and its 12-month low (in this case, 3.5%). A reading of 0.5 would represent the official trigger of the rule; a few more months of unemployment readings of 4% or better would achieve that goal.

The rule has applied to every recession dating back to at least 1948, so it can serve as an effective warning sign when values ​​start to increase.

Even as the unemployment rate continues to rise, Fed officials have expressed no concern about the labor market. After last week’s meeting, the rate-setting Federal Open Market Committee called the job market “strong,” with Chairman Jerome Powell telling a news conference that conditions were “back to where they were on the eve of the pandemic — relatively tight.” But not overheating.

In fact, officials slashed their personal forecasts for rate cuts this year, down from three expected at the March meeting to just one this time.

CME Group said the measure surprised markets, which were still expecting two interest rate cuts this year. Fed Watch A measure of the federal funds futures market contract.

“Bad results here can be very bad,” Sam said. “From a risk management perspective, it’s hard for me to understand the Fed’s reluctance to cut rates and their continued hawkish rhetoric on inflation.”

Sam said Powell and his colleagues are “playing with fire” and should be concerned about the pace of change in the labor market as a potential harbinger of future dangers. She added that it would be dangerous to wait for job growth to “deteriorate,” as Powell said last week.

“There’s a reason recession indicators are based on change. We’re already in a recession, and unemployment rates vary,” Sam said. “These dynamics will have their own effects. If people lose their jobs, they will stop consuming (and) more people will lose their jobs.”

However, the Fed finds itself at a crossroads.

Tracking a recession with such low unemployment goes back to the second half of 1969 and into 1970. On several occasions in recent days, including on Tuesday, central bank officials have said they believe inflation is moving in the right direction but are not yet confident enough to start cutting interest rates.

Depend on Inflation, the Fed’s preferred barometer, was 2.7% in April, or 2.8% if food and energy prices are excluded from the core reading that policymakers pay special attention to. The Fed’s inflation target is 2%.