The US Labour Market: Cooling, but not collapsing

The US labour market is clearly slowing but, in our view, calls for an imminent recession look overstated.

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After the release of July’s payrolls data, worries about the health of the US labour market and a potential US recession re-emerged. One of the key features of the report was an unexpected rise in the unemployment rate that triggered the ‘Sahm rule’, a measure that has historically been a reliable indicator of US downturns.

However, we believe the current state of the US labour market is somewhat less concerning compared to previous breaches of the Sahm rule threshold. Specifically, increases in the unemployment rate have so far been driven more by increased participation and immigration than by layoffs. Alongside this, there are currently fewer recessionary warning signals elsewhere in the economy.

Thus, while the US labour market is clearly slowing, we’d need to see more deterioration in the job cuts or employment data before becoming materially concerned about a US recession.

What is the Sahm rule?

The Sahm rule compares the most recent three-month moving average of the unemployment rate to its 12-month low. Historically, if the most recent datapoint is 0.5 percentage points or more above the 12-month low, the US economy has been in, or about to enter, a recession.

The rationale behind the Sahm rule is that unemployment tends to rise gradually before picking up meaningfully. That is, relatively small increases in the unemployment rate over a short period can foreshadow future, larger rises, as laid-off workers cut back on spending, forcing further layoffs.

July’s payrolls data led to labour market worries

The Sahm rule threshold was met in July’s payrolls data, when the unemployment rate rose to 4.3%. This increase took the three-month average more than 0.5 percentage points above its 12-month low of 3.6%.

Exhibit 1: Sahm rule: US unemployment rate relative to recent low

% points, three-month moving average unemployment rate minus lowest value over prior 12 months

Exhibit 1

Source: BLS, Claudia Sahm, LSEG Datastream, J.P. Morgan Asset Management. The Sahm rule is triggered when the three-month moving average of the unemployment rate rises by more than 0.5 percentage points versus its lowest level over the prior 12 months. Periods of recession are defined using US National Bureau of Economic Research (NBER) business cycle dates. Data as of 30 August 2024.

It is important to note that the Sahm rule is an empirical regularity, rather than an economic rule. Nevertheless, it has been triggered in or before every US recession since the 1970s, and has not given ‘false positives’ in the past.

But there are some confounding factors

There is reason to believe that, while the US labour market is slowing, the state of play is unlikely to be as worrying as the Sahm rule might suggest.

Recent rises in the US unemployment rate have been driven by increased labour supply, rather than a jump in layoffs – the layoff rate remains historically low. The US economy continues to create jobs, but this job creation is not quite fast enough to offset the number of people joining the workforce.

Exhibit 2: Breakdown of US unemployment

Millions, change over previous 12 months

Exhibit 2

Source: BLS, LSEG Datastream, J.P. Morgan Asset Management. Data as of 30 August 2024.

The US labour force has been expanding due to two factors: rising participation, and a surge in immigration. Labour force participation is at levels last seen in 2001, and a post-pandemic immigration surge is adding meaningful numbers of workers to the labour force each month.

In the shorter-term, rising participation may not always be positive – it can sometimes reflect part of the population being ‘forced’ into (or back into) the labour force thanks to economic pressures. Thus, rises in participation can sometimes be a signal of stress.

However, this does not appear to be the case today. US wage growth remains elevated, with consumers’ purchasing power increasing as pay gains exceed inflation. The lowest income quintiles do appear to be facing some pressure, as seen in deposit balances and credit card debt data. But broadly the US consumer looks resilient, as Claudia Sahm – the inventor of the Sahm rule – has herself pointed out.

Instead, rising participation appears to be driven by other factors. A growing US economy tends to encourage workers back to the labour force thanks to attractive wages, as seems to be the case today. Female participation is also at historic highs, potentially due to improving workplace flexibility. These are positive reasons for workforce growth.

Alongside rising participation, a surge in immigration has also boosted the US labour force. Foreign-born workers made up nearly half of the increase in the US workforce in 2023, and immigration has remained strong through 2024.

Exhibit 3: US labour force growth

Millions, change year on year

Exhibit 3

Source: BLS, LSEG Datastream, J.P. Morgan Asset Management. Data as of 30 August 2024.

The labour market is slowing, but not collapsing

Labour supply has risen in or before previous US recessions, so today’s growing workforce alone does not negate the signal sent by the Sahm rule. Furthermore, there is clear evidence that the US labour market is slowing: payrolls growth has decelerated over recent quarters and wage growth, while elevated, has retreated materially from its highs.

However, it appears unlikely that the US labour market is in recession just yet. Layoffs remain muted and the forces driving today’s expanding labour force appear to be fairly positive.

Conclusion

The Sahm rule has proved a good heuristic for judging when the US economy is in recession in the past. However, there are reasons to believe its triggering may be somewhat less worrying today.

The US labour market is clearly slowing but, in our view, calls for an imminent recession look overstated. Today’s rises in unemployment are driven by labour supply expanding faster than jobs are added. Crucially, the reasons behind this rise in labour supply look positive. Currently, some version of a ‘soft landing’, where growth slows but does not collapse, remains our base case for the US.