Historically, the labour market is always the last part of the business cycle to break.

This cycle, given the difficulty of finding qualified workers post-COVID-19, is likely even more leveraged to the health of the U.S. worker/consumer. You have likely heard that consumer credit for the lower half of income earners is already being stretched.

You have also likely heard that most of the jobs created in the U.S. over the past year have been part-time jobs. It’s clear from these two metrics that the labour market (i.e. the consumer) is fragile.

This chart shows the pre-COVID-19 recessions and U.S. Initial Jobless Claims. Historically, the lower end of weekly claims was about 300,000 in recent decades given the 150 million plus of the labour force. The recent post-COVID-19 layoff levels have been closer to 200,000, so still pretty low overall. But it’s clear that employment is the key to recessions.

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Claudia Sahm, a former U.S. Federal Reserve economist, created an indicator that has forecast every recession in the post-Second World War period by looking at the rate of change in the unemployment rate. And while this cycle is unique in many ways given the rebalancing of the world’s supply chains and reversal of the globalization theme of recent decades, we expect the indicator to still be a reliable forecasting tool.

That said, we heard a call with Sahm following the recent U.S. employment report saying that she looks at the “totality” of the economy, not just the labour market.

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The rule takes the U3 (unemployment rate) and takes a three month average compared to the 12 month low. If the rate is 0.5 per cent above the low point of the past year, the odds of a recession are 100 per cent. The indicator is not flashing a recession yet, but it is close.

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You can follow the indicator of the St. Louis Fed economic database (FRED). There is no guarantee it works this time and there is no good way to forecast when the labour market will trip the signal, but it should be the focus for the Fed’s dual mandate going forward.

With the S&P 500 and NASDAQ 100 priced for perfection, a recession would certainly challenge the upside potential for the markets.

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