Economic Outlook: Morgan Stanley’s Perspective on the Sahm Rule

Investing.com reports that the Sahm Rule recession threshold was breached following the July jobs report. However, Morgan Stanley suggests that this ominous indicator may not be reliable in the current economic cycle and predicts a soft landing for the economy.

What is the Sahm Rule?

The Sahm Rule indicates a recession when the three-month average U.S. unemployment rate increases by 0.50% or more from its 12-month low. In July, it hit this threshold, yet Morgan Stanley believes it provides misleading information due to recent labor force increases.

Alternative Indicators

Economists at Morgan Stanley express skepticism towards both the Sahm Rule and the Michaillat and Saez indicators. Instead, they prefer the employment-to-population ratio (EPR), which also has a recession threshold of 0.5%, but is currently at 0.3%.

The Michaillat and Saez model is acknowledged for its value, focusing more on labor demand and utilizing two thresholds to assess recession probability. Morgan Stanley combines this with the EPR to form the Triumvirate Rule.

Triumvirate Rule Findings

Using the Triumvirate Rule, there’s a 22% probability of a recession starting, compared to a 16% likelihood of negative GDP growth in Q3.

Morgan Stanley concludes that, while these indicators reinforce a baseline expectation of a soft landing, there is a cautionary note given the rise to a 22% probability.

Historically, the Triumvirate Rule indicates a 100% chance of recession within 2 to 6 months after surpassing 20%, averaging 3.7 months, suggesting that investors should remain vigilant.