Lots More With Claudia Sahm on What the Sahm Rule Is Saying Now

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1:08Bloomberg Audio Studios. Podcasts, radio, news. Hi, Claudia. Hello. How are you doing? Good. How are you doing? Pretty good. It's a little calmer this week, so no. Oh, yeah. Last week was a little nuts. Last week was nuts. Oh, my gosh. Yeah. So good to catch breath. Sometimes I wonder if you have a Google Alert set up for SOM and if it's just like going off constantly in the past 10 days. There were several hits of my Google Alerts the last couple. I don't have one on the SOM rule. I think that probably would have been even more out of control. I did a deadlift. One, two, three. Hegemony. Okay, good.

1:55Hegemony. Barges. This is an after-school special, except... I've decided I'm going to base my entire personality going forward on campaigning for a strategic pork reserve in the U.S. Where's the best squid ink pasta? These are the important questions. Is it robots taking over the world? No, I think that like in a couple of years, the AI will do a really good job of making the Odd Lots podcast. And people will say, I don't really need to listen to Joe and Tracy anymore. We do have... Cha-ching. The perfect guest. You're listening to Lots More, where we catch up with friends about what's going on right now.

2:30Because even when the odd lots is over, there's always lots more. And we really do have the perfect guest. We are speaking with Claudia Somm, of course, the creator of the Somm Rules. She is chief economist at New Century Advisors and also a columnist at Bloomberg. And you've been in the news a lot recently, Claudia, because actually, I can't figure this out. Has your rule actually triggered or not? It has, the way that I calculated the SOM rule. And it was very close to the trigger. So the value in July is 0.53, and the threshold is 0.5 or above. And there have been people doing various calculations of the same principle of change in the unemployment rate relative to the past 12 months.

3:22And you can get very small differences depending on how you do it. I think that just says, I mean, it's right at the edge, but the official SOM rule is triggered. And every time I write about the SOM rule, I'm always like only 99 % sure or 90 % sure I remember what it is. And I always go look it up. But it's what it basically states is that when the three month moving average of the unemployment rate is 0.5 % above the 12 month low, then historically in post-World War II recessions, every single time that has happened, every time it's written above, gotten above half a percent, a recession came soon thereafter.

4:01Is that correct? Yeah, half a percent or more. Half a percent or more, sure. And historically, and in particular, that very kind of precise record is in the data as it was published at the time. Right. So, right. So right around, but in principle, yes. And you know, the important things you take the three month moving average, so you smooth out over time, you take that current value three month average, look at the low of the three month averages over the prior 12 months, not including the current, the prior, and those are the changes. And, but it It all is, I think, like the formula, the thresholds very much go back to the purpose of it, which was to create an indicator, a simple one to initiate fiscal relief.

4:53So like stimulus checks, extra jobless payments. So it needed to be something simple. And it needed to happen in the recession. So like the recession is already here. The SOM rule is not a forecast. It typically has triggered about three months in. to recessions historically. And it's not meant to get ahead of it. It was meant to. It's here, the unemployment rate has started to rise. We know in recessions, it continues to rise. A half percentage point increase in unemployment rate is not a big deal. This is not a worrisome feature in and of itself. It's where it tends to go from there that makes the recessions damaging.

5:31Wait, so this is important. So the origin of the rule is that you wanted something that was dependable that you could use as more or less immediate guidance for the government to actually come in and do something about recession. But because the rule is also encoded and calculated in a very specific way, so the U.S. is entering recession whenever unemployment is running 0.5 percentage points higher than the prior 12 months flows, because it's set in stone, it also cannot take into account, I guess, differences in the current economic environment or maybe nuances that are not necessarily captured by those hard numbers.

6:16Right. Because again, the goal was looking back over history, what is the formula, the rule that would get to turn on fiscal relief, so stabilization, as early as possible in a recession so it could do the most good and also be as accurate as possible, right? Just looking back over history. So in the United States, you can look back over several decades. I mean, I'm looking across several different recessions, different kinds of features. And yet there have been, and this is a theme of this entire cycle since the pandemic began, some very unusual disruptions that the pandemic kicked off. And the SOM rule is now in a long list of our kind of macroeconomic tools that have fallen victim to features, particularly supply, very abrupt supply shocks that just aren't there to the same extent in the historical record.

7:16So that's where the pattern, it relies on a pattern and a dynamic that's really powerful. It's happened for post-World War II period, and yet it is not infallible and had an opportunity to talk about this for, I found posts from two years ago explaining why the SOM rule might break. And certainly, this is where it's been headed. But that's instructive too about what's actually going on right now in the economy. And it is not to say that all is good with the labor market, even if the SOM rule says it's a recession and we do not have a recession. There is information here about the health of the labor market, some concerning signs in the labor market.

7:53Right. So you developed this rule in part to guide counter-cyclical fiscal policy. Right now, it's pretty clear that we're nowhere near any sort of political will. We're going to start sending checks again. So if there's going to be a response to the weakness, it's going to come on the monetary policy side. Expectation is for some sort of rate cut in September. When we got that last unemployment report and the SOM rule did technically trigger, there was a lot of debate. Is it different this time? This isn't really driven by layoffs. It's about the fact that there's a lot of entrance into the labor force and the hiring rate has slowed down, et cetera.

8:29I guess what I would start is what is, from your perspective, okay, the rule is triggered. what is the case for sort of quibbling or people trying to explain away or, oh, the headline unemployment isn't quite that bad this time and, oh, layoffs are still pretty low. That strikes me as a sort of risky line of dialogue, but I'm curious your take. Yes. So it is always risky to go down the this time is different. There's a long historical record of explaining away bad news that that ends up being actually, it was bad news. And that was your chance to see it. So no, I take this very, yeah, this is, this is tough, right?

9:10It's been tough to think about what's wrong here and pull out the actual, like what's the right message from the labor market. And it's nuanced. There's not a simple message. I push back pretty strongly on the idea of, oh, well, we haven't seen the layoffs. If you look in some of this is, I understand like the, These measures like the SOM rule, these things where you're looking at these small changes on employment rate, these are features early in recessions. Recessions do have a, they turn on, right? It is actually a, the economy starts to contract. It's a subjective decision of the National Bureau of Economic Research experts on when we go into a recession and we come out, but there is a, the economy starts to contract.

9:54And the early phases of a recession, like the early six months, say, of a recession, often, 2020 was an exception, but often are a slow grind into it, right? You can see the signs of the contraction, but the unemployment rate often usually peaks, gets to its highest level after the economy has come out of the recession, right? So those layoffs, if you wait to see mass layoffs, you are typically well in to a recession, right again covid came just out of nowhere and so rapidly that if our mind is set on what covid doesn't even look like a recession like it just it because of it just looks like a shock to our system which it was so the this whole like oh we don't see it in the layoffs i don't buy that i worry one of the things that even when i push back on my own rule this is and saying it's not but it's overstating the weakness, is one feature.

10:54I mean, we've seen right now that the firing rate is still very low, right? So from like the job opening labor turnover survey, we're still very low levels. The hiring rate has come down. I mean, it had been very high, labor service has come down. And it's now at levels that are like 2014 levels, which wasn't a particularly good labor market. So you do have businesses who really got burned from mass layoffs under COVID, labor shortages, trying to hire back, all of this difficulty. Now they're holding on to workers. So what does that tell us? Employers, to some extent, have likely changed the way, like that pattern of how they adjust to their demand for workers.

11:40Right. You can do it through, and often hiring will show up much sooner in terms of it weakening. So it's the firing rate being very low right now. It doesn't give you much cover because the firing rate tends to go up as the recession proceeds. Like in no way, shape, or form am I arguing the recession started six, nine months ago, right? That's not a relevant comparison. And then I think we have some evidence that that margin of holding on to workers versus hiring workers may have shifted some from the pandemic. So it's kind of like you get it has to go all ways. Right. If you have a pattern, if COVID has really disrupted a pattern in the labor market that works in favor of saying, oh, well, it's actually not as bad this time as it would normally look.

12:33Well, you've got to be careful that there aren't stories that unwind it just the other way.

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13:31Support for the show comes from public.com. You're thoughtful about where your money goes. You've got your core holdings, some recurring crypto buys, maybe even a few strategic option plays on the side. The point is you're engaged with your investments and public gets that. That's why they built an investing platform for those who take it seriously. On public, you can put together a multi-asset portfolio for the long haul. Stocks, bonds, options, crypto, it's all there. Plus an industry leading 3.6 % APY, high yield cash account. Switch to the platform built for those who take investing seriously.

14:04Go to public.com slash market and earn an uncapped 1 % bonus when you transfer your portfolio. That's public.com slash market. Paid for by Public Investing. All investing involves the risk of loss, including loss of principal. Brokered services for U.S.-listed registered securities, options, and bonds in a self-directed account are offered by Public Investing, Inc., member FINRA, and SIPC. Crypto trading provided by ZeroHash. Complete disclosures available at public.com slash disclosures. Joe, you've talked about this, right? The idea that in some ways, unemployment can be exponential and can kind of start feeding on itself.

14:39Yeah, exactly. Yeah. And to Claudia, I mean, to your point, which is technically, I think the recession, the financial crisis recession ended like in the summer of 2009. The unemployment rate in that cycle, it actually technically peaked in the October 2009 report at 10%. So that was after, to your point, Claudia. So why would it be different this time? I mean, like you say, there's this danger and yes, COVID messed with stuff, et cetera, but I just pulled up the hiring chart, the hiring rate. It's back in 2014 levels. Why shouldn't we take the signal that your rule says quite seriously? We should take the increase in the unemployment rate seriously in terms of the direction, right?

15:24It is rising. There is weakening demand for labor. Yes. And that that is so like setting all of this aside about the summary recession, not a recession, like the direction we are on is a until it levels out is a problem. OK. Right. And we can talk about their reasons. You know, the Federal Reserve has interest rates high because they are fighting inflation. It should not be a real surprise that the unemployment rate is drifting up. Right. Right. In that sense. So there's that aspect of we can chuck the SOM rule if you want to, but it's like keep an eye on the unemployment rate and what it's doing and what's going on underneath it.

16:01And the piece that right now is this puzzle, and this is the thing that the SOM rule was too simple, too simplistic in trying to get at, is that separating out changes in unemployment. So unemployment rate rising because there's a weakening demand for labor. And that can show up in a lot of ways. It doesn't just have to be layoffs. can also be lack of hiring, right? So anything that's weakening demand of labor, that pushes up the unemployment rate. And that can be very pernicious because a worker without a paycheck or a smaller paycheck buys less. And then that business needs fewer workers. So that's the dynamic we're trying to shut off.

16:37Okay. So that's a bad dynamic. That's clear. It's in there. And yet what's also in there this time is you have shifts in the supply of workers. So labor supply. And the summer rule works, it looks at the changes in unemployment rate, which you have to do with the history. Because we have gone into recessions at all different levels of unemployment. Like a low level of unemployment does not protect you from a recession. It's about these dynamics. So when there are two things have happened with this, and there are other indicators, I think, that are out there, kind of labor market that are struggling with the same issue, is that early in the pandemic, we had a plunge in the labor force.

17:22Millions of people just walk away from work. Some of them came back, but many didn't, early retirements or other. We lost, and you'll see a lot of times in beginning recessions, there's a decline in the labor force, right? There are patterns of labor supply back in history around recessions. And yet this is huge. And what then happened is when customers came back quickly, some of those workers did not come back or came back much more slowly. And we had labor shortages. The unemployment rate early in the recovery, when you get to the depths of like 3.4 % unemployment rate and you're in a labor shortage, one of the reasons that unemployment rate is so low is because you have too few workers.

18:04Right. It's like labor supply is pushing it down. So we've got like starting points that are probably pushed down because we've been missing workers. And then we get to a place that we've seen in the last few years, those labor shortages. Amazingly, the labor shortages were addressed with more workers, not fewer customers, which is like the thing the Fed can get us, fewer customers, but it got more workers. And there's a portion, particularly this very big abrupt change was in immigration into the United States. And that's actually made it hard in our measurement even. It's very hard for me with any conviction to quantify exactly how much of this labor supply effect because it's not just that there's increasing labor supply.

18:50We've had recessions. 1970s had increases in labor force. We had entrants into the labor market contributing as the Sommel triggered. But what we've had this time are just these big swings in one direction, the other direction. And so then when that piece is in there, you get it. Now we have what looks like some of the increase in unemployment rate is coming from more labor supply over the interim. I mean, higher unemployment is always bad for the unemployed person, right? Like they're looking for a job. But when we look at that high unemployment and think about where it's headed, if it's coming primary from labor supply and especially an abrupt, then it's more of a matching.

19:37Like we need the jobs to catch up now. And as they catch up, well, then the unemployment rate will drift down or at least settle down. Right. And then once you're getting workers, when you get more workers into the economy, it's the exact opposite of a recession dynamic. It's an expansion dynamic because you've got more workers. You can make more. So you have like totally opposite. You know, is this increased unemployment rate a really bad sign? Is this increased unemployment rate a really good sign? Unfortunately, the best we can do right now is to say these two things are both in play. And to watch them carefully.

20:17And that's where I think taking seriously the weakening part of the labor market, because there are policy levers to pull with the Federal Reserve, can get those under control and then help that kind of catch up process of jobs. Like the stronger the job market is, the faster we can bring in these workers. So this is kind of the other reason why your Psalm Google alert would have been going off like crazy over the past week or so is there's also like everything in the world nowadays, at least in the US, there seems to be this intense politicization of this particular economic rule and of the jobs market and of what the Fed should do.

20:59And I think like some of the irony of the current moment is you see accusations that the Fed is behind the curve. You see accusations that if it cuts in September before an election, that's because it's trying to support the Democrats and support Kamala Harris. And you've been kind of on the receiving end of some of that commentary. What do you say to people who think this is all about politics and justifying downwards momentum in the labor market at a very politically sensitive time? So to be honest, I haven't tried to engage in that discussion because I didn't think, I mean, the SOM rule, it's a tool.

21:41This is a really important time to have a robust discussion about what's happening in the U.S. labor market from the vantage point of policymakers or businesses, households. Right. So I that it is timed with an election year. That's unfortunate. But I had you know, I had been aware, like realizing this dynamic before last week, you know, there had been as an example, people had looked at these state level changes in unemployment rates. So like kind of state SOM rules. And I've written about this also. Like there were some states like California that have had larger increased unemployment rate.

22:17And there were quite a few that had hit the half a percentage point. There is no state SOM rule, but, you know, using that trigger. And I, and this was several months ago, like in the spring, writing about this. And I got a lot of pushback from some people that I wasn't, I wasn't being true to my rule because there was a Democrat in the White House and I wasn't willing to say a recession. And, you know, for all this, it's like I wouldn't wish a recession on anyone. Like, I don't care who's in the White House. But it is an election year, and I'm not that naive. And I understand that people – and recession is a very charged – I mean, it's a very bad experience.

22:56And it also has meaning beyond its actual definition. So I'm not surprised. It's unfortunate. And I certainly, I mean, I think with looking at these, I mean, it's called a rule because it's a policy prescription, right? It's not a rule. We must have a recession. It's supposed to be a prescription of policy. And this is not creating panic or concern where I think if you look broadly at the economic conditions, like output, consumer spending, income, like the U.S. economy is not contracting. And even after we go through revisions, I think it's going to be hard to say July 2024 was a recession. I just don't see that.

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25:34Learn more at chase.com forward slash business card. Chase for Business. Make more of what's yours. Accounts subject to credit approval. Restrictions and limitations apply. Cards are issued by JPMorgan Chase Bank and a member FDIC. This is my summary of your views and tell me if I'm wrong. There are reasons to think that unlike past times when the SOM rule has triggered, we may not be in a recession because other economic data looks good and much of the upward push in the unemployment rate is due to the influx of labor supply. Yet, on the other hand, there is this clear deceleration in demand for labor.

26:12And so regardless of the recession question or not and the specific trigger and what it says, that from a sort of policy and risk management move, it's a good time for the Fed to essentially go in the other direction or essentially engage in stimulative policy one way or another. Yeah, at this point, they can just take their foot off the brake a little bit. This isn't even, because again, this is where when Fed policymakers or Fed Chair Jay Powell, the last press conference before we got the July data, essentially saying, we the Fed don't want to see more weakness in the labor market, more weakening.

26:51And it's like, well, you left rates uncut, right? It's like, what do you think is going to happen? The direction here is really clear. And what I have a very hard time of without appealing to the Fed reducing interest rates, I think it's a hard story to tell as to what it is that levels it out. Right. What is it that helps us stay at this place? And yeah, it creates the demand for labor. Yeah. Or just, yeah, it creates the demand, levels out this weakening. I agree. The labor market was really firing on all cylinders and labor shortages were very disruptive. So we were going to see job gains slow.