Zero false alarms! The indicator that accurately predicted recessions after World War II is flashing red: the U.S. economy may have already entered a recession

How can the Recession Cycle Index be adjusted through the labor force participation rate to improve prediction accuracy?

Source: Jin10 Data

For months, economists have been debating whether the United States is about to fall into a recession. But an economic indicator suggests that much of these debates have already become meaningless.

Moody’s Analytics chief economist Mark Zandi said that, based on the Recession Cycle Index (VCI) created by his team, the U.S. economy may already be in a recession.

The indicator identifies whether the economy has entered a recession by measuring the pace at which the unemployment rate is rising. It is an upgraded version of the Sam Rule after adjustments for the labor market. The Sam Rule’s criterion is: if the three-month average unemployment rate rises by more than 0.5 percentage points above the low point of the previous 12 months, it signals a recession. The Recession Cycle Index adjusts the unemployment rate using a five-year moving average of the labor force participation rate. If the three-month average rises by more than 1 percentage point compared with one year ago, a recession warning light will turn on. Zandi said that the index rose by more than 1 percentage point in January and has remained at a high level over the past three months.

“After every recession since World War II, this indicator has nailed it accurately—there has never been a false alarm.” Zandi wrote on LinkedIn. “Once the indicator triggers, even if the National Bureau of Economic Research’s Business Cycle Dating Committee needs some time to confirm, 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 U.S. recession over the coming year, mainly because the oil shock triggered by the Iran war has disrupted the entire economy. Consumer confidence has remained sluggish, and employment data had been disappointing before last month. Some economists have even warned about the risk of stagflation, worrying about dual pressure on both economic growth and employment. Although March added 178,000 new jobs, beating expectations, Zandi believes that this data masks the economy’s true condition.

“Don’t get too pleased with the big jump in March employment data.” Zandi posted on X. “Earlier in February, employment fell sharply due to the extreme cold snap and the Kaiser Medical institution strike, and March’s data is just a rebound. He noted that the new jobs do not reflect the impact of the Iran war on the economy. If you exclude the healthcare sector, U.S. employment is actually hemorrhaging.”

Has the U.S. really entered a recession?

On LinkedIn, Zandi said that the current Recession Cycle Index is close to 5%, meaning the labor market is weaker by far than what March’s employment data suggests. “This indicates that as discouraged workers completely exit the labor force, the degree of labor market slack is more severe than what the official unemployment rate shows.”

This assessment aligns with Diane Swonk, chief economist at KPMG, in her interpretation of the March jobs data. “The unemployment rate is down, but the reasons aren’t reliable: it’s due to a decline in labor force participation.” Swonk said in a recent interview with 《Fortune》.

Of course, the Recession Cycle Index is only a proprietary indicator, and the Sam Rule it references is also not absolutely reliable. The indicator flashed red in the summer of 2024, but the U.S. did not fall into a recession, largely thanks to a “soft landing” enabled by rate cuts. In February this year, the Sam Rule rose by only 0.26 percentage points, far below the 0.5 percentage point threshold for triggering a recession. However, just like false signals from the Sam Rule, the Recession Cycle Index also cannot ensure that the U.S. economy has already entered a recession. Zandi conceded that in the current special economic environment, the indicator could still be wrong.

In the face of the multiple headwinds confronting the U.S. economy, Federal Reserve Chair Jerome Powell has not paid attention to stagflation concerns. “Over the past few years, the U.S. economy has faced many major challenges, yet it has remained steady—that is truly noteworthy.” Powell said after the Fed announced last month that it would keep interest rates unchanged.

Even so, several institutions have already raised recession expectations. Moody’s Analytics forecasts a 48.6% chance of a U.S. recession over the next year, Goldman Sachs puts it at 30%, and EY-Parthenon at 40%. Zandi believes that at least the Recession Cycle Index is enough to help the market view the eye-catching employment data from March more rationally.

“At the very least, the Recession Cycle Index is another important reason why we should not overestimate the significance of the March employment growth.” He wrote.