The Glone and Mail - 01.08.2019

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B8 O THEGLOBEANDMAIL| THURSDAY, AUGUST 1, 2019

GLOBEINVESTOR

| REPORTONBUSINESS

T

he U.S. jobs numbers that
will be published this Fri-
day offer a quick, relatively
simplewaytogetareadingonthe
healthoftheworld’slargestecon-
omy – especially if you view them
through an intriguing new filter.
ThefilterisknownastheSahm
recession indicator after its cre-
ator, Claudia Sahm, an economist
at the Federal Reserve. She found
that one of the surest and fastest
ways to know whether the United
Statesisinarecession–orheaded
toward one – is to look at changes
in the unemployment rate. Even
apparently small shifts can have
large implications for the eco-
nomic outlook.
The Sahm indicator compares
the average unemployment rate
over the past three months to its
lowest reading over the past year.
Itshowsthatiftheaverageunem-
ployment rate over the most re-
cent three months is more than
0.5 of a percentage point higher
than its lowest three-month aver-
ageoverthepreceding12months,
the U.S. economy is nearly cer-
tainly in recession.
For anyone overwhelmed by
the flood of economic numbers –
some of them positive, some of
them negative – the Sahm indica-
tor is an ingenious new tool. Un-
like recession alarms that rely on
the yield curve, or excess bond
premiums, or other statistical
wizardry, the new indicator re-
quires only basic math.
The trickiest part is finding
monthly U.S. unemployment
readings. (If in doubt, go to the
Federal Reserve Bank of St. Louis
siteatfred.stlouisfed.organdtype
in “civilian unemployment
rate.”) You then have to calculate
three-month averages for each

month of the past year. Why

three-month averages? Because

you want to smooth out transient

blips in the data.

The reward for this number-

crunching is a handy gauge for

judging the health of the U.S.

economy – and, because of spill-

over effects, the prospects for

Canadiangrowth,aswell.Basical-

ly, the Sahm signal says that the

surest warning sign of a recession

is a sustained upward tick in un-

employment. This makes intui-

tive sense and is much quicker

than waiting for more traditional

gauges to flash red.

The National Bureau of Eco-

nomic Research, the official arbi-

ter of recessions in the United

States, took a full year after the fi-

nancial crisis started before it fi-

nallydeclaredinDecember,2008,

that the country was in recession.

Other signposts of recession,

such as the rule of thumb that in-

sists gross domestic product

must shrink for two quarters in a

row, also require considerable

time to register a downturn.

Incontrast,theSahmindicator

has “correctly signalled a reces-

sionfourtofivemonthsfollowing

the beginning of the recession

and has virtually never called a

recession incorrectly since 1970,”

according to a recent analysis by

the Brookings Institution, a think

tank in Washington.

TheSahmindicatorcanalsobe

used to monitor the rising risk of

a recession. For instance, if the

mostrecentthree-monthaverage

unemployment is just 0.2 per-

centagepointshigherthanitslow

point over the past year, the

chance of a recession in the next

year jumps to 39 per cent.

What is noteworthy right now

is how upbeat the Sahm indicator

is heading into Friday’s jobs num-

bers. With unemployment be-

tween April and June averaging

3.63 per cent, and the lowest

three-month average over the

preceding year at 3.66 per cent,

the Sahm gauge is a hair below

zero – minus 0.03 percentage

points, to be precise. That indi-

cates next to no chance that a U.S.

recession has already started. It

also suggests there is only a low

probability (10 per cent) of a re-

cessioninthenext12monthsand

only a modest chance (25 per

cent)ofoneinthenexttwoyears.

The Sahm indicator is consid-

erably more optimistic than

some alternative gauges. For in-

stance, the Federal Reserve Bank

of New York bases its recession

probability index ongovernment

bondspreads.Itputstheoddsofa

U.S. recession over the next year

at nearly 33 per cent – high

enough to induce anxiety in

many investors.

The Sahm indicator would

starttoflashasimilarlevelofcon-

cern only if the latest three-

month average of unemploy-

ment moves at least a 10th of a

percentage point higher than its

lowest level over the past year. At

that point, it, too, would indicate

a 33-per-cent chance of a reces-

sion over the next year.

To register such a warning, U.S.

unemployment for July would

have to move up to at least 3.9 per

cent. A recession would still not

be a done deal, however, until the

Sahm index passed 0.5 percent-

age points, which, as things now

stand, would mean unemploy-

ment readings above 4 per cent

for at least three months.

Investors may want to monitor

this new recession signal. It offers

the chance to update your views

on the U.S. economy every

month. It is also a useful counter-

weight to some of the gloomier

forecasts out there.

HowtheSahmindicatorcanpredictaU.S.recession

Toolcomparesaverage

unemploymentrate

overpastthreemonths

toitslowestreading

fromthepastyear

IAN
McGUGAN

OPINION

PROBABILITY OF A RECESSION BY SAHM RECESSION INDICATOR, 19 7 0-2019

THE SAHM RECESSION INDICATOR, 19 7 0-2019

U.S.unemployment rate (three-monthaverage) relative to prior 12-month low

JOHNSOPINSKI/THEGLOBEANDMAIL, SOURCE:THEBROOKINGSINSTITUTION

(DATAVIABUREAU OF LABOR STATISTICS;CLAUDIA SAHM; REAL-TIMEESTIMATESOFUNEMPLOYMENT RATE)

RecessioM

Mow

RecessioM

iM 3 mo.

RecessioM

iM 6 mo.

RecessioM

iM12mo.

RecessioM

iM24mo.

Less than 0

SahmRece

ss

ioMIMdicato

r

(pctg. point increase in unemployment rate)

Percentage point difference

1% 2% 5% 10% 25%

0to0.09 2 5 8 20 39

0.10 to 0.19 2 13 23 33 37

0.20 to 0.29 11 33 33 39 39

0.30 to 0.39 40 40 40 40 40

0.40 to 0.49 76 76 76 76 76

GreaterthaMor

equalto0. 50 97 97 97 97 97

Probability of recession

at any unemploy. rate

12 15 19 25 38

1970

U.S. recession

1974 1978 1982 1986 1990 1994 1998 2002 2006 2010 2014 2018

4.5

4.0

3.5

3.0

2.5

2.0

1.5

1.0

0.5

0.0

-0.5

ProposedrecessioM

iMdicatorthreshold

of 0. 5 perceMtagepoiMt

The reward for this

number-crunching

is a handy gauge for

judging the health of

the U.S. economy –

and, because of

spillover effects,

the prospects for

Canadian growth,

as well.

T

he apocalypse for overex-
tended borrowers was can-
celled on Wednesday.
Thank the U.S. Federal Re-
serve, which cut its trendsetting
interest rate by one-quarter of a
percentage point. In a stroke, the
Fed killed the expectation that
interest rates would rise back to
historically normal levels and
crush people with big debts.
This may still happen in the
long run. But for now, the global
economy is stuck in a slow-
growth rut and may even be los-
ing momentum. There’s no justi-
fication for higher rates, other
than the hunger of conservative
investors and savers for better re-
turns.
The Fed move affects Cana-
dians in a bunch of important
ways. Lower rates are good for
stocks, which have already been
on a tear in 2019. U.S.-bound
travellers, you may find that the
exchange rate you get when con-
verting Canadian dollars into U.S.
currency improves some. Our
dollar could benefit if rates are
stable here and falling in the
United States.
But it’s borrowers who will be
affected most by the Fed’s rate
cut, though in an indirect way

because the Bank of Canada is

expected to hold rates steady

here. This view was reinforced by

a report on the economy for May

that showed a reasonable level of

growth.

As the Bank of Canada’s over-

night rate goes, so go the costs of

borrowing through home equity

lines of credit, floating rate loans

and variable-rate mortgages.

Rates on these borrowing vehi-

cles are locked in as long as the

Canadian economy holds up.

Rates on fixed-rate mortgages

have fallen this year and the

trend looking ahead is favoura-

ble if you’re renewing a mort-

gage or buying a house. The cost

of fixed-rate mortgages follows

what’s happening in the bond

market, where interest rates

have fallen hard in the past 12

months.

The Fed’s rate cut validates the

view in the bond market that ec-

onomic growth is slowing, that

inflation is no threat and that in-

terest rates need to be lower.

Lenders seem to disagree on just

how low mortgage rates should

be, however.

Discounted five-year fixed-

rate mortgages at national mort-

gage brokerage firms were avail-

able on Wednesday at 2.69 per

cent, while major banks were

showing special offers of 2.97 per

cent to 3.39 per cent. You may

have to consult a mortgage bro-

ker to squeeze the most benefit

out of falling borrowing costs.

Today’s rate environment is a

weird one because, in an inver-

sion of the normal way of things,

short-term borrowing costs are

actually higher than long-term

costs. One of the mortgage bro-

kerage firms offering the 2.69-

per-cent five-year fixed-rate

mortgage showed a rate of 3.04

per cent for one year, 2.89 per

cent for two years, 2.79 per cent

for three years and 2.94 per cent

for four years.

Five-year fixed-rate mortgages

are the best all-around value to-

day – you get five years of not

having to worry about your

mortgage rate and an exception-

ally low rate, period. Even varia-

ble-rate mortgages can’t com-

pete. Usually available at lower

rates than fixed-rate mortgages,

a discounted five-year variable

rate mortgage today is going at

rates of 2.9 to 3.3 per cent.

What’s good for borrowers is

generally bad news for savers

and conservative investors. Re-

turns on high-rate savings ac-

counts are holding firm for the

most part because they’re linked

to what the Bank of Canada is

doing. But guaranteed invest-

ment certificates mirror what

mortgages are doing, which

means returns are shrinking. If

you have GICs to buy or renew,

don’t delay.

The interest rate outlook to-

day is a 180-degree shift from a

year ago, when the Bank of Cana-

da was still raising rates. The

country absorbed those rate in-

creases fairly well, although the

national savings rate has fallen

to almost nothing.

Now, borrowers get a reprieve

from even higher borrowing

costs. It’s a gift – don’t waste it by

getting complacent about your

debt load or, worse, by borrow-

ing more. The more debt you pay

off this year and next, the better

prepared you’ll be for whatever

happens in the economy.

Remember, rates are being

lowered to address concerns

about the economy. Lightening

your debt load and building your

savings are the best defence.

TheU.S.FederalReservejustsavedCanadianswhoborrowedtoomuch

ROB
CARRICK

OPINION

Rates on borrowing

products, such as home

equity lines of credit,

floating rate loans and

variable-rate mortgages,

are locked in as long as

the Canadian economy

holds up.ISTOCK