Will Fed policy trigger a US recession?

The Sahm Rule Trigger:

• The unemployment rate's three-month average rose by 0.53 percentage points above its 12-month low in July 2024, technically triggering the Sahm Rule recession indicator for the first time since its 2019 inception.
• Historically, the rule has a 100% success rate in identifying recessions from 1970 onward when triggered; however, Claudia Sahm notes the indicator is meant to confirm a recession, not forecast one, and may have false positives if the unemployment rise is driven by labor supply shifts rather than demand destruction.
• Sahm argues the current rise is a "mixed bag," partially caused by a supply shock from unexpected labor force entrants (e.g., immigration) which is not a recessionary signal, though hiring and quit rates have declined, indicating weakening demand.

Goldman Sachs Research Outlook:

• Goldman Sachs economists assign a 20% probability to a U.S. recession within the next 12 months, a figure that could drop to 15% if the upcoming August payrolls report is benign.
• The firm forecasts three consecutive 25 basis point rate cuts occurring in September, November, and December.
• The base case assumes the economy is not currently in contraction, citing continued growth in income, consumer spending, and job creation.

Expert Disagreement on Recession Probability:

• Claudia Sahm: Views the recession risk as "not a huge" immediate threat but warns the economy is moving in a negative direction due to high interest rates; she fears a recession would constitute a "huge unforced policy error" if the Fed fails to cut rates.
• Bill Dudley: Estimates the odds of a recession at 50-60% over the next 12 months, citing the "self-reinforcing dynamic" where rising unemployment scares households and businesses, leading to reduced spending and hiring.
• Rob Kaplan: Expresses less concern regarding the immediate recession risk, characterizing the potential Fed lag as a "tactical error" (1-2 meetings) rather than the "strategic error" seen in 2021-2022.

Fed Policy and "Behind the Curve" Debate:

• Fed Chair Powell signaled an intent to cut rates in September, but Sahm and Dudley argue the Fed risks being "behind the curve" by not acting sooner to prevent the unemployment rise from spiraling.
• Dudley notes that monetary policy lags are "long-term variable" in both directions, making it difficult for the Fed to intervene quickly enough to prevent a downturn, unlike the successful soft landing of the mid-1990s.
• Rob Kaplan advises the Fed to maintain "hawkish rhetoric" while preparing to cut rates to keep all policy options open, cautioning against overreacting to single data points like the weak July jobs report.
• Dudley warns that while the Fed aims for a "soft landing," history shows it is rare for the Fed to prevent a rise in unemployment during such events, and any failure could lead to a recession.

Structural and Data Interpretation Risks:

• Dudley warns that current economic data (GDP, employment) may be over-optimistic due to underlying assumptions about business formation and failure rates that often turn out to be incorrect during turning points.
• Sahm highlights the difficulty in interpreting current data due to the "Achilles heel" of the unemployment rate: shifts in labor force participation can distort the metric independent of demand conditions.
• Kaplan advises investors to look beyond short-term "bouncing ball" data (CPI, PCE) and focus on structural factors like demographics, technology disruption, and the energy transition.

Forward-Looking Statements and Scenarios:

• Base Case: A mild recession or no recession if the Fed cuts rates decisively to relieve downward pressure from the current 5%+ federal funds rate.
• Downside Risk: If the Fed waits for further inflation data or reacts to a strong August report, the risk of an "unforced" recession increases.
• Worst-Case Scenario (Dudley): A mild recession driven by financial imbalances being relatively low, as household and business balance sheets remain strong due to pandemic-era fiscal transfers.
• Upside Scenario (Kaplan): The August report may revert to a "normal" trajectory, validating the view that the July anomaly was a temporary aberration rather than a trend.