The unemployment measure you’ve never heard is flashing a recession warning

Happy Fed day, in what will be a momentous decision not just for the fact that it will herald the beginning of an interest rate-cutting cycle but for the uncertainty over the magnitude of the reduction.

The last time the interest rate for a Fed decision was set more than 10 basis points away from market expectations was March 3, 2020 — the emergency cut at the beginning of the COVID pandemic, points out Michael Brown, senior research strategist at Pepperstone. That gives the interest-rate cycle a symmetry — uncertainty on the way up, and uncertainty on the way down.

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But it may be a puzzle as to why the Fed is cutting rates at all when the economy is far from recession — the Atlanta Fed’s GDPNow estimate of third-quarter growth is a healthy 3% — and inflation is still above target.

David Kotok, the chief investment officer of Cumberland Advisors who hosts an annual summer gathering in Maine of investors and other financial market participants, points to a warning from an employment measure that doesn’t officially exist. It’s called U-7, invented by David Blanchflower, the Dartmouth labor economist who served on the Bank of England’s monetary policy committee.

U-7 is actually not hard to compile — it’s a simple calculation involving two measures of underemployment that the Labor Department produces each month. It yields the number of part-time workers who want full-time jobs as a percentage of the workforce.

The bond market curve recently dis-inverted — that is, the yield on the 2-year Treasury returned to being lower than the 10-year — for the first time since July 2022. Is that good or bad? Yes, reply analysts at Goldman Sachs. The median six-month return following disinversions since 1950 for a host of different assets depends on whether the economy is in, falls into, or avoids recession. The one rather obvious exception is gold.

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