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Risk of US Recession on the Rise

New research from the St. Louis Federal Reserve Bank has indicated that over half of the 50 US states are showing signs of slowing economic activity, a key threshold that often signals an impending recession.

Anxious Man in the Middle of a Downtrend Chart
Anxious Man in the Middle of a Downtrend Chart

This follows a report from the San Francisco Fed earlier in the week that also explored the increasing possibility of a US recession in the coming months.

Falling Activity in the US States

According to the St. Louis Fed report, if 26 states have declining activity within their borders, there is a "reasonable confidence" that the nation as a whole will enter a recession. Using data from the Philadelphia Fed tracking the performance of individual states, the report found that 27 states had declining activity in October. While this points to a potential downturn, it falls short of the numbers seen ahead of previous recessions. For example, 35 states experienced declines before the short and sharp recession of the spring of 2020.

Unemployment Rate as an Indicator of Recession

The San Francisco Fed report, released on Tuesday, noted that changes in the unemployment rate could also signal an upcoming recession. This indicator has a more near-term predictive value than the closely-watched bond market yield curve. The report found that when the unemployment rate bottoms out and begins to rise, it typically signals the onset of a recession about eight months later.

This pattern, known as the Sahm Rule after former Fed economist Claudia Sahm who first linked rising unemployment to economic downturns, has been found to be highly reliable. The San Francisco Fed report added that its innovation is to make the unemployment rate change a forward-looking indicator.

FED Building
FED Building

Stable Unemployment Rate in the US

In contrast to the state data from the St. Louis Fed indicating a potential recession, the US unemployment rate has remained relatively stable. After bottoming at 3.5% in September, it held steady at 3.7% in both October and November. However, the San Francisco Fed report noted that the Fed's December forecasts predict the unemployment rate will rise next year as the central bank implements aggressive rate hikes to combat high levels of inflation. In 2023, the Fed expects the unemployment rate to jump to 4.6% amid only modest levels of overall growth. If this forecast comes to pass, the report stated that "such an increase would trigger a recession prediction based on the unemployment rate."

Fed Focused on Inflation, Employment Concerns

The possibility of a US recession has raised concerns due to the Fed's strong actions on inflation. Some critics argue that the central bank is prioritizing inflation over employment, while the Fed has countered that without returning to price stability, the economy will struggle to reach its full potential.

In a press conference following the most recent Federal Open Market Committee meeting, Fed Chair Jerome Powell said that he did not view the current outlook as a recession prediction, as growth is expected to remain positive. However, he acknowledged that there is still a lot of uncertainty.

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