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Canada’s Sahm Of All Fears

The Sahm Rule, named after former Federal Reserve and Council of Economic Advisors economist Claudia Sahm, indicates that a US recession has begun when the 3-month moving average of the national unemployment rate rises by 0.5 percentage points or more relative to its low during the prior 12 months. As outlined in a previous piece, it has not yet reached that threshold in the United States.

In Canada, a slightly higher threshold is needed – calculations are performed differently in each country, and the level of unemployment is typically higher north of the border. Claudia addressed this in a 2021 blog post, suggesting that a 0.6-percent trigger was more appropriate, with the only false positive on the historical record coming in 1996.

With unemployment already 0.7 percentage points higher than its 12-month low and likely to go higher when updated numbers are published on Friday, it is clear that the trigger conditions for a Canadian recession have been met – but it remains difficult to tell how deep it might be.

Market consensus suggests that a mild US and Canadian slowdown is in the offing, and interest rate swap pricing is pointing to a closely-aligned response from the Federal Reserve and Bank of Canada in the year ahead.

Our instincts* tell us that this is too optimistic, with enormously high debt levels in the household and corporate sectors likely drag the Canadian economy into a more painful and prolonged downturn, with a less housing- and consumption-driven growth model emerging at the end. The Canadian dollar might rise through year end on a lift-all-boats dynamic as markets reprice expectations for the Federal Reserve, but could be poised for renewed weakness in the first quarter of next year.

*Our instincts are far from infallible

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