Top American economists warn: If the Federal Reserve does not cut interest rates, it is "playing with fire" and may push the economy into a recession

According to the financial news app Smart Finance, former Federal Reserve staff and economist Claudia Sahm pointed out that if the Fed does not cut interest rates now, it may risk pushing the economy into a recession. When the three-month average of the unemployment rate is half a percentage point higher than its 12-month low, the economy is in a recession.

With the recent rise in unemployment levels, the so-called "Sahm Rule" is increasingly sparking discussions on Wall Street, indicating cracks in what was once a strong labor market and hinting at potential trouble. This has in turn sparked speculation about when the Fed will start cutting interest rates. (The "Sahm Rule" is an economic recession prediction indicator proposed by Claudia Sahm. This rule judges whether the economy is entering a recession based on changes in the unemployment rate. Specifically, the core condition of the Sahm Rule is: when the three-month average of the unemployment rate is 0.5 percentage points higher than its 12-month low, it indicates that the economy is in a recession.)

As the Chief Economist of New Century Advisors, Sahm stated that the Fed taking no action to gradually cut interest rates now is taking a big risk: without action, the Fed risks the "Sahm Rule" taking effect, which could lead to an economic recession and force policymakers to take more drastic actions.

"My baseline is not a recession," Sahm said, "but this is a real risk, and I don't understand why the Fed is willing to take this risk. I'm not sure what they are waiting for."

She added, "At this point, the worst possible outcome is the Fed causing an unnecessary economic recession."

As a numerical indicator, based on the May employment report from the Bureau of Labor Statistics, the value of the Sahm Rule is 0.37, showing the unemployment rate rising to 4% for the first time since January 2022. This is the highest point the Sahm Rule value has risen since the early days of the COVID-19 pandemic.

This value actually represents the percentage point difference between the three-month average unemployment rate and its 12-month low of 3.5%. If the value reaches 0.5, this rule will be triggered; if the unemployment rate remains at 4% or higher for the next few months, this situation may occur.

This rule has applied to every economic recession since 1948, so when the value starts to rise, it serves as an effective warning signal.

Despite the rise in unemployment levels, Fed officials have shown little concern about labor market performance. After the meeting last week, the Federal Open Market Committee, which sets interest rates, labeled the job market as "strong," and Chairman Jerome Powell stated in his press conference that conditions are "back to pre-pandemic levels, relatively tight but not overheated."

In fact, officials significantly lowered their expectations for interest rate cuts this year, from the expectation of 3 rate cuts (at the March meeting) to 1 rate cut at this meeting.

This move surprised the market, although according to the "FedWatch" index from the Chicago Mercantile Exchange Group, the market still expects two rate cuts this year "The bad outcomes here could be very bad," Sahm said. "From a risk management perspective, I find it hard to understand why the Fed is unwilling to cut interest rates and their relentless tough talk on inflation."

Sahm said that Powell and his colleagues are "playing with fire" and should pay attention to the speed of changes in the labor market as a potential harbinger of future dangers. She added that waiting for "deterioration in job growth," as Powell mentioned last week, is dangerous.

"Recession indicators are based on reasons for change. We have entered recessions at various levels of unemployment," Sahm said. "These dynamics interact. If people are unemployed, they stop spending, and more people become unemployed."

However, the Fed finds itself at a crossroads.

The last recession that began with such low unemployment dates back to the late 1969 to 1970 period. In addition, the Fed rarely cuts interest rates when unemployment reaches this level. Recently, including last Tuesday on multiple occasions, central bankers have said they see inflation moving in the right direction but do not yet have enough confidence to start cutting rates.

According to the Fed's preferred inflation gauge, the inflation rate in April was 2.7%, or the core reading (excluding food and energy prices) was 2.8%. The Fed's inflation target is 2%.

"Inflation has fallen significantly. It has not reached the level you would hope for, but it is moving in the right direction. Unemployment, however, is moving in the wrong direction," Sahm said. "In balancing these two, you are getting closer to the danger zone in the labor market and further away from the danger zone in terms of inflation. What the Fed should do is obvious."