Before releasing the surprising U.S. employment data on the first Friday of October, the dominant market discussion was whether the Federal Reserve would repeat a half-point cut at its November policy meeting. While Fed officials emphasized their determination not to allow further cooling in the labor market, at least one-third of market participants were betting on another half-point rate cut due to recession concerns signaled by the Sahm Rule. 

However, the latest data from the U.S. showed that the Fed has no justification for proceeding with an aggressive easing path. After two months, the Sahm Rule indicator returned to the 0.5% threshold, and bets on a significant cut next month dropped to zero. 

While both the Fed and markets were focused on labor market risks, mixed inflation reports have ignited a new debate about the Fed’s policy trajectory. Although price pressures have eased in the U.S., led by declining energy costs, service prices remain stubbornly high. While the headline figure progresses toward the target, the core figure diverges. 

Moreover, as job growth remains resilient, wages in the private sector continue to rise strongly. This is good news for U.S. households, supporting their consumption patterns and economic growth. However, this also complicates the decision-making processes for policymakers who hope to remove inflationary psychology from the equation. 

A consensus has formed that the Fed will ease policy gradually in the upcoming period. This has led to an increased focus on soft landing scenarios. However, upcoming data could significantly influence market expectations and policymakers' decisions.  

Have Recession Fears Been Overblown?

Following the fears of a recession in August, the swift shift towards inflation concerns has raised questions about whether the initial recession fears were overblown. 

The National Bureau of Economic Research (NBER) is considered the authority to declare when a recession officially starts and ends in the U.S. NBER defines a recession as a "significant decline in economic activity that is spread across the economy and lasts more than a few months." However, for NBER to announce a recession, it must assess a range of economic data, which takes time. 

In contrast, the Sahm Rule is an early indicator of any potential recession. The Sahm Rule suggests that the U.S. economy is in recession if the three-month average unemployment rate rises by 0.50% or more from its lowest level in the previous 12 months. 

Indeed, while the NBER has not announced a recession, the fear in the markets was sparked when the Sahm Rule indicator surpassed the threshold in July at 0.53%, the first time since March 2021. The indicator rose to 0.57% with the August employment data but returned to the 0.5% threshold in September. 

Many economists, including Claudia Sahm, the creator of the Sahm Rule, have emphasized that the U.S. economy is not in recession despite what the indicators may suggest. One primary piece of evidence was the continued momentum in economic growth. According to the latest figures, U.S. economic growth in the second quarter was revised to 3%, and moreover, the Atlanta Fed’s GDPNow forecast shows third-quarter growth at 3.2%. 

Additionally, Federal Reserve Chair Jerome Powell pointed out that the Sahm Rule is not an economic law but a “statistical regularity.” While the indicator has accurately signaled recessions since the 1970s, the 0.5% threshold may not account for changes in business cycles following the pandemic. Many economists argue that the threshold might be higher due to the rapid growth in the labor force. 

On the other hand, September’s employment data indicated a robust labor market. However, recent hurricanes and labor strikes in the U.S. are expected to cause fluctuations in the data over the coming months. In the October report, Fed Governor Christopher Waller estimated that these factors could reduce job growth figures by more than 100,000. Such a report would push the Sahm Rule indicator above the threshold again. However, since the job losses are attributed to temporary factors, there should be no renewed surge in recession fears. 

In conclusion, for the Fed to accelerate rate cuts in the near future, significant deterioration in the labor market would be required. Besides, the inflation reports will determine whether the Fed’s rate-cutting cycle will pause or not. Unexpected increases in inflation could lead to a halt in the cuts. Therefore, the critical macroeconomic data set to be released towards the end of the month may shed light on the path ahead.