Recession signs that were formerly considered reliable are starting to resemble smoke detectors with dead batteries, complaining nonstop but maybe not warning of a serious threat, according to some of the world’s leading economists.
The prognosis for a recession has been erratic recently, with worries peaking early and subsiding as contradictory assessments on the state of the American economy emerged. Some economists are comfortable disregarding the inverted yield curve and the Sahm Rule, two classic instruments for predicting recessions, amid this whiplash.
Since the COVID-19 outbreak began to recede, economists have speculated whether the US economy would experience a recession. As the economy expanded and prices rose quickly in 2021, their arguments gained traction. A significant economic downturn usually follows a period of rising inflation.
Since then, inflation has decreased to levels similar to those before the pandemic, although a recession is still a possibility. Economists find some of their traditional instruments less helpful as they venture into uncharted territory because the current economic conditions differ greatly from previous recessions.
A jittery bond market
The bond market is the most consistent source of recession worry. The yield on two-year Treasury bonds has been greater than the yield on 10-year Treasury bonds since July 2022. In a healthy economy, longer-term securities typically have higher yields than short-term ones, not the other way around. The yield curve inverts when investors anticipate a recession.
Bond dealers are anticipating a recession and accept lower yields on longer-term debt. One is that they believe the Federal Reserve, which frequently lowers interest rates during recessions, will eventually reduce its benchmark interest rate.
Lower Fed rates are imminent. Fed Chair Jerome Powell recently stated that the moment had come for policy to change, as the labour market was cooling and inflation remained low.
The Fed has gradually raised its significant Fed funds rate from near zero since March 2022. To discourage borrowing and spending, slow the economy, and stop runaway inflation, this has increased the cost of borrowing for credit cards, mortgages, auto loans, and other debt. The Fed raised interest rates to their highest level since 2001 in July 2023, and they have remained at that level ever since.
Since then, inflation has decreased almost to what it was before the COVID-19 pandemic. It would be historically unusual if inflation dropped to the Fed’s target 2% yearly rate without causing an economic meltdown. A recession typically follows a Fed rate hike aimed at curbing inflation.
Nevertheless, it’s plausible that bond investors are bracing for a “soft landing” instead of a recession.
CIBC analyst Avery Shenfeld commented, “Investors, as a group, aren’t buying into the US recession thesis at this point.”
Rather, he believes that the market’s actions align with the idea that rates are down due to the defeat of inflation and that a relaxation of policy would prevent a complete economic collapse.
By September 2025, the Fed funds rate is expected to be in the range of 3% to 3.5%, according to the CME Group’s FedWatch programme, which predicts changes in the Fed rate based on Fed funds futures trade data. The Federal Reserve has historically lowered the Fed funds rate to near zero to inject easy money into the economy during recessions.
Enters the Sahm Rule
The Sahm Rule, which bears the name of its author, economist Claudia Sahm, is another formerly trustworthy indicator.
The rule is predicated on the finding that previous recessions have been preceded by a specific spike in the unemployment rate that rapidly spirals out of control and results in a mass loss of jobs. The Department of Labour released a report in August 2024 that indicated the unemployment rate had increased to the point where the Sahm Rule took effect.
This is bad news for the economy because, over the past 50 years, the Sahm Rule has proven to be accurate when applied to recessions. However, several economists, including Sahm herself, doubt that there has been a real economic slowdown.
“Contrary to the historical signal from the Sahm Rule, we are not currently in a recession, but the trend is moving in that direction. There is significant room to cut interest rates, and a recession is not inevitable,” Sahm told CNBC.
During previous recessions, firms laid off employees, which increased the unemployment rate. This time, more people are looking for work, which has contributed to an increase in the unemployment rate, which simply indicates the number of job seekers without employment. Storms in July may also have caused a brief increase in it.
When he lowered his prediction for the recession to 20% at some point in the upcoming year from 25% earlier this week, Goldman Sachs chief economist Jan Hatzius rejected the applicability of the Sahm Rule to the current circumstances. He pointed out that countries like Canada have recently had notable increases in their jobless rates without experiencing the total collapse of their economies.
Might there be a fire?
According to economist Richard M. Salsman of the libertarian think tank American Institute for Economic Research, the ongoing yield curve signal and the Sahm Rule’s recent warning should be taken seriously.
In a week-long commentary, Salsman said, “The two measurements together are significant and informative. We receive two signals: one indicates that a recession is approaching, and the other suggests it will occur within the next 12 to 18 months. The knocks on doors are growing louder and more forceful. There is something in the world.”
Financial markets closely monitor every new report for indications that either side is correct. Early in August 2024, the S&P 500 stock index experienced a significant decline as several indicators suggested the economy slowed down. In the following weeks, the market rose as inflation and retail sales data reduced the likelihood of a recession.
As long as the outlook for a recession remains uncertain, this whiplash could persist. More unexpected developments may occur before interest rates stabilise at a new normal. The Fed’s high interest rates have already had wide-ranging effects, including fuelling an unexpected wave of bank failures last year.
While some economists, such as Salsman, urge caution, interpreting these signals as signs of an impending downturn, others remain optimistic that inflation control efforts and potential interest rate cuts will prevent a major economic collapse. The financial markets, reflecting this uncertainty, have experienced fluctuations as data points like inflation and retail sales bring hope of stability.
Furthermore, the current economic climate has prompted some analysts to consider alternative indicators that might provide a clearer picture of what lies ahead. For instance, consumer confidence indexes and business investment trends are closely watched as potential harbingers of economic health.
Recent data shows that consumer spending has remained robust, buoyed by a strong labour market and wage growth. This resilience in consumer behaviour suggests that households still have the financial capacity and willingness to spend, which could help sustain economic growth despite other warning signs.
Additionally, the housing market offers mixed insights. While higher interest rates have cooled housing demand to some extent, leading to a slowdown in new construction and sales, housing prices in many regions remain elevated due to limited supply. This indicates that the market is adjusting rather than collapsing, which differs from patterns observed in previous recessions where housing market downturns significantly contributed to economic declines.
Another factor to consider is the role of technological innovation and its impact on productivity. Sectors like artificial intelligence (AI), renewable energy, and biotechnology may drive new waves of economic growth. Innovations in these fields may offset negative economic forces by creating new industries and job opportunities, thereby supporting overall economic stability.
Global economic conditions also add layers of complexity to the US outlook. Supply chain disruptions have eased (barring the aviation sector) compared to the peak COVID period, but geopolitical tensions, such as trade disputes and conflicts, continue to pose risks.
The interconnected nature of global markets means that economic slowdowns in major economies like China or the European Union could have ripple effects on the American economy. Conversely, coordinated international efforts to stimulate growth could provide a supportive backdrop for the world’s largest economy.
Labour market dynamics further complicate the picture. The unemployment rate has risen modestly, but job openings remain plentiful, and employers report difficulties filling positions. This suggests that the labour market is experiencing a rebalancing rather than a contraction. Structural shifts, such as increased remote work and changing worker preferences, may be influencing employment patterns in ways that traditional indicators do not fully capture.
As the debate intensifies, it becomes clear that the US economy is in an unprecedented situation. The post-pandemic recovery has shifted the dynamics, making some of the most trusted recession indicators less effective in predicting the current economic trajectory. Analysts and policymakers are caught between traditional economic wisdom and a new reality where factors like high inflation, fluctuating unemployment rates, and global economic conditions defy expectations.
The Federal Reserve’s cautious approach to adjusting interest rates, alongside mixed signals from the bond market and employment reports, has left economists divided on whether a recession is imminent or if the economy can manage a “soft landing.”
Financial institutions are also better capitalised compared to previous economic downturns, thanks in part to regulatory changes implemented after the 2008 financial crisis. This improved financial stability reduces the likelihood of a banking crisis exacerbating any economic slowdown.
However, higher interest rates have increased borrowing costs, which could strain businesses and consumers with high levels of debt, potentially leading to increased default rates if economic conditions worsen.
In light of these multifaceted factors, some economists advocate for a more nuanced interpretation of the data. They suggest that while caution is warranted, the economy may be transitioning to a new equilibrium rather than heading toward a recession. This perspective emphasises the adaptability of the economy and the possibility that it can adjust to challenges without experiencing a significant downturn.
Ultimately, the path forward may depend on the agility of policymakers and the private sector in responding to emerging trends. Proactive measures, such as targeted fiscal stimulus, investments in infrastructure, and policies that support workforce development, could bolster economic resilience. Collaboration between government, industry, and communities will be crucial in addressing both immediate concerns and long-term structural challenges.