American traders are closely watching this "key indicator", which will determine the next move of the US stock market

As the US labor market cools down, the market is closely watching the famous recession indicator "Sahm Rule".

Federal Reserve Chairman Powell's "dovish" remarks overnight, stating that the labor market is significantly cooling down, have stimulated US stocks to hit new highs again. With the US stock market hovering near historic highs, traders are also focusing on the prospects of interest rate cuts this year, as rising unemployment rates are causing concerns about an economic recession.

A recession may bring risks to the current US stock market. Currently, Wall Street's tilt towards the technology industry has reached historic levels. Once the rebound driven by artificial intelligence shows signs of instability, risks will increase. Lisa Shalett, from Morgan Stanley's wealth management department, warned of issues such as "lack of momentum, weak breadth, and complacency" in the market.

The "Sahm Rule" has become a key focus in the current market. When the 3-month average of the unemployment rate rises by 0.50 percentage points above the lowest value of the past 12 months, a recession is triggered. This rule accurately predicted economic recessions since 1970.

Claudia Sahm, the creator of this rule and a renowned economist, recently warned that if the Federal Reserve does not cut interest rates soon, it may push the economy into a recession.

Recession Warning Signs Flashing

The "Sahm Rule" is widely regarded as a reliable indicator for predicting economic recessions.

In recent months, with a slight increase in the unemployment rate, concerns about the labor market conditions have also increased.

In June, the Sahm Rule value was 0.43, approaching the caution line of 0.5. The June non-farm report showed that the unemployment rate further rose from 4% in May to 4.1%. Sahm stated:

The Federal Reserve is taking a big risk by not gradually cutting interest rates now. If no action is taken, the Federal Reserve may trigger the "Sahm Rule," leading to an economic recession, which may force policymakers to take more aggressive actions.

Federal Reserve officials seem to be starting to worry about the labor market conditions. During a hearing on Tuesday, Powell stated that the labor market is significantly cooling down, no longer a widespread source of inflationary pressure. Previously, the Federal Reserve had long considered an overheated labor market as one of the main risks to curb falling inflation.

Sahm: Not Cutting Rates Now is "Playing with Fire"

Sahm warned that the Federal Reserve is "playing with fire":

They should pay attention to the rate of change in the labor market because this is a potential harbinger of future dangers.

Waiting for employment growth to "deteriorate" is dangerous. We have experienced recessions at different unemployment levels, and these dynamics are self-reinforcing. If people lose their jobs, they will stop consuming, and more people will become unemployed.

Federal Reserve officials have repeatedly stated recently that they believe inflation is moving in the right direction. However, it is not yet enough to start cutting rates. According to the Federal Reserve's preferred inflation gauge, the core PCE price index, excluding food and energy prices, rose by 2.6% year-on-year, hitting a three-year low but still above the 2% target.

Sahm believes:

Inflation has dropped significantly, although it has not reached the level you want, it is moving in the right direction, while the unemployment rate is moving in the wrong direction

Balancing these two, you are getting closer to the danger zone in the labor market, but moving further away from the danger zone in terms of inflation. It is quite clear what the Federal Reserve should do