US Fed's high rates spur slowdown fear, heightens chances of recession

The turmoil shaking global financial markets reflects a sudden fear that the Federal Reserve may have held its key interest rate too high for too long, heightening the risk of a US recession.

Economists and Wall Street traders now expect the Fed to cut its benchmark rate, which influences borrowing costs for consumers and businesses, much faster than they thought just a week ago. Chair Jerome Powell has often stressed that the Fed could quickly lower rates if it decides that it's needed to bolster the economy.

The periodic fear of a forthcoming recession has been a hallmark of the post-pandemic economy and has proved wrong every time. Instead, contrary to what most analysts have predicted, steady economic growth and a solid pace of hiring have endured.

In the past, the US economy would often flash telltale signals when it was in or near a recession. But those red lights have gone haywire since the COVID-19 pandemic struck and upended normal business activity.

The latest red flag was Friday's July jobs report from the Labour Department, which showed that the unemployment rate rose from 4.1 per cent to 4.3 per cent still a relatively low level but the highest rate in nearly three years. Markets panicked after the report was released, in part because it set off the so-called Sahm Rule.

Named for Claudia Sahm, a former Fed economist, the rule has found that since 1970, a recession has always been underway once the three-month average unemployment rate has risen by half a percentage point from its low of the previous year. The logic behind the rule is that unemployment can be self-sustaining: As more people lose jobs, they cut back their spending, harming other companies, which then stop hiring or even cut workers.

Yet the Sahm Rule could be yet another recession signal that turns out to be a false alarm. Sahm herself doubts that a recession is imminent.

The rule is typically triggered when companies start cutting jobs, thereby raising the unemployment rate. Yet now, unemployment has been rising not because companies are slashing jobs but because so many people have poured into the job market. Not all of them have found work right away.

Jay Bryson, chief economist at Wells Fargo, thinks the risk of recession has risen along with the unemployment rate. But he ultimately thinks the economy will pull through.

The good news here," he said, "is that there haven't been any major shocks hitting the economy, such as a spike in oil prices or a housing bust. Absent a shock, it's a bit more challenging to get into a recession.