Soft landing still in sight as Sahm Rule recession indicator misses more than hits

Investing.com -- The 'Sahm Rule' recession threshold was breached in the wake of the July jobs report, but Morgan Stanley believes this doomsday indicator's prophetic powers are foggy during the current cycle and still sees a soft landing for the economy.  

The Sahm Rule - a measure suggesting a recession is underway when the three-month average U.S. unemployment rate rises by 0.50% or more from its 12-month low - reached its recession threshold of 0.5% in July, but Morgan Staley said in a recent note that its economists think "the Sahm Rule misleads more than it informs in this cycle, given the recent increase in the labor force."

Morgan Staley economists aren't big fans of the Sahm Rule nor the Michaillat and Saez, and instead prefer an indication that comes from the employment-to-population, or EPR, ratio, which has the same 0.5% recession threshold as the Sahm Rule, but at 0.3% hasn't yet reached that level. 

The Michaillat and Saez does have merit, the economists add, as it focus more on labor demand and than supply, and also uses two thresholds - a lower and higher - to calculate the probability recession. By combining this approach with the preferred employment-to-population indicator to create a the "Triumvirate Rule." 

According to the Triumvirate Rule, we calculate a 22% probability that a recession began, they added,  comparing to the 16% probability professional forecasters assigned to negative real GDP growth in Q3.  

"In the end, these indicators continue to support our economist's baseline for a soft landing," Morgan Stanley said, though warned that there was reason to be cautious as the rule at 22% has breached a notable level.

"The Triumvirate Rule has moved to 100% probability of recession within 2 to 6 months after rising above 20% historically, with an average of 3.7 months. This suggests investors should continue to exercise caution," it added.