Economists have been debating for months whether the United States is heading towards a recession. However, one economic indicator suggests that much of this debate may already be moot. According to Mark Zandi, Chief Economist at Moody's Analytics, the US economy may have already slipped into a recession, based on the Vicious Cycle Index (VCI) created by his team. This indicator identifies an economic recession by measuring the speed of rising unemployment rates. It is an enhanced version of the Sahm Rule, adjusted for the labor market. The Sahm Rule's criterion is that a recession is signaled when the three-month average unemployment rate rises more than 0.5 percentage points above its low from the previous 12 months. The Vicious Cycle Index adjusts the unemployment rate using a five-year moving average of the labor force participation rate. A recession red light flashes when its three-month average rises more than 1 percentage point compared to a year ago. Zandi stated that this index exceeded the 1 percentage point threshold in January and has remained elevated over the past three months. "This indicator has accurately signaled every post-World War II recession, with zero false alarms," Zandi wrote in a LinkedIn post. "Once the indicator triggers, even if the NBER Business Cycle Dating Committee takes time to confirm it, we are already in a recession." Multiple headwinds have reignited market concerns about a recession. Many economists, including Zandi, have raised their probability of a US recession within the next year, primarily due to oil shocks stemming from the conflict involving Iran disrupting the broader economy. Consumer confidence remains persistently low, and employment data was weak until last month. Several economists have even warned of stagflation risks, concerned about pressures on both economic growth and employment. Although March saw a better-than-expected addition of 178,000 jobs, Zandi believes this figure masks the economy's true condition. "Don't be fooled by the strong March job growth," Zandi posted on platform X. "February jobs were depressed by extreme weather and the Kaiser Permanente strike; March's number is just a bounce-back." He pointed out that the job gains do not reflect the economic impact of the conflict involving Iran, and excluding the healthcare sector, US employment is actually in decline. Has the US economy truly already entered a recession? Zandi indicated on LinkedIn that the current Vicious Cycle Index is nearing 5%, suggesting labor market weakness is far more severe than what the March jobs data shows. "This indicates that labor market slack is worse than the official unemployment rate suggests, as discouraged workers drop out of the labor force altogether." This assessment aligns with the interpretation of the March jobs data by Diane Swonk, Chief Economist at KPMG. "The unemployment rate fell, but for the wrong reason: it was due to a drop in labor force participation," Swonk said in a recent interview with Fortune. Of course, the Vicious Cycle Index is just one proprietary indicator, and the Sahm Rule it references is not infallible. This indicator flashed a red light in the summer of 2024, but the US avoided a recession, largely thanks to a "soft landing" aided by interest rate cuts. In February of this year, the Sahm Rule had risen by only 0.26 percentage points, well below the 0.5 percentage point trigger threshold. However, like the Sahm Rule's potential for false signals, the Vicious Cycle Index cannot guarantee the US economy is already in a recession. Zandi acknowledged that, given the unique current economic environment, the indicator could still be wrong. In the face of multiple headwinds confronting the US economy, Federal Reserve Chair Jerome Powell has dismissed stagflation concerns. "The US economy has performed remarkably well in the face of really significant challenges over the last couple of years," Powell said last month after the Fed announced it was holding rates steady. Nevertheless, several institutions have raised their recession expectations. Moody's Analytics forecasts a 48.6% probability of a US recession within the next year, while Goldman Sachs estimates 30%, and EY-Parthenon puts it at 40%. Zandi believes that, at the very least, the Vicious Cycle Index provides a strong reason for markets to view the impressive March jobs data rationally. "At a minimum, the Vicious Cycle Index is another important reason we should not over-interpret the strong March job gain," he wrote.
Comments