Slight Uptick in Unemployment Could Spell Recession

There is a very fine line between a soft landing and a hard landing when it comes to the economy, and the difference may come down to just a few points on the upcoming unemployment report.

A hard landing means the U.S. economy goes into a recession, said Marcus & Millichap SVP of research services John Chang in a research video. A soft landing, on the other hand, means economic growth moves very close to zero but doesn’t fall into negative territory. One way economists will try to predict a potential recession is using the Sahm Rule, which compares the average unemployment rate over the past three months with the lowest monthly unemployment reading over the previous 12 months. If the difference is 50 basis points or more, the risk of a recession is high, said Chang. Since May, the unemployment rate has increased by 20 basis points to 4.1%, translating to a 43 on the Sahm indicator.

“A lot will be riding on the July unemployment rate that comes out on August 2, which just so happens to be two days after the next Fed meeting where they’ll decide what to do with interest rates,” noted Chang.

If the unemployment rate goes down, the Sahm indicator will go down, and in theory, the country would avoid a recession for now. If the unemployment rate stays flat, the Sahm indicator will creep up to 47, still below the official recession threshold of 50. But if the unemployment rate goes up by 10 basis points to 4.2%, then the Sahm indicator will hit 50 exactly, and that indicates we’re likely heading into a recession. Another reliable recession indicator is the three-month-10-year treasury yield curve, which indicates we should theoretically already be in a recession.

“If the July unemployment rate reading is 4.2% or higher, then the two most reliable recession indicators would be blinking, and the pressure on the Fed to cut rates will mount,” said Chang.

The Fed faces a tricky decision about what to do with rates and when. If they hold rates flat at the end of July and unemployment rises, a hard landing becomes a real possibility. If they cut rates and unemployment goes down, inflation could spike. If they wait until their next opportunity to drop rates on Sept. 18, it may be too late, said Chang.

Real estate investors have a lot on the line. Lower interest rates will help close the pricing expectation gap, but a recession could dampen demand, push vacancy rates higher, and reduce future rent growth.

“A mild recession may have very little effect on commercial real estate performance, especially if it’s a short recession,” noted Chang. “At this point, if we have a recession at all, it’s very likely to be mild.”