Over the last year, mainstream bull market pundits have harped on the strong U.S. labor market.
In fact, this has been the main argument for the “soft landing” thesis – aka that the Federal Reserve can bring inflation down and cool a hot economy without setting off a recession.
Why?
Because when more people have jobs, there's increased demand in an economy that relies 68% on consumer spending1, thus keeping things humming along.
- Remember, someone’s spending is someone else's income, and on and on.
And while this argument makes sense (and I agree with it), there’s a fatal flaw in it – which is the fact that the labor market is showing signs of weakness. . .
Thus, while many focus on the national unemployment rate remaining relatively low at 4.1% (although it’s risen from 3.6% this time last year and is now the highest since November 20212), I think it’s better to focus on the indicators that dictate where employment is going.
Or as Wayne Gretzky – the famous hockey player – once said: "Skate to where the puck is going to be, not where it’s been."
With that said, let’s look at where this puck may be going in the labor market. . .
These Three Leading Indicators Signal Trouble for U.S. Labor
Three important indicators are signaling some issues to come in the labor market.
The Kansas City Fed's Labor Market Conditions Index - Talk About "Ouch"
First, let’s look at the Kansas City Fed’s Labor Market Conditions Index (LMCI) – a historically accurate leading indicator for the overall health of the U.S. labor market.
- The Kansas City LMCI are monthly measures based on 24 variables that assess labor market activity and momentum.
In short, when the LMCI declines, the unemployment rate generally rises. And vice versa.
But keep in mind, there are two important things to note here:
- The LMCI is a leading indicator (meaning indicators that change before general economic conditions, which can help predict turning points in the business cycle).
- Whereas the unemployment rate is a lagging indicator (meaning it moves only after macroeconomic conditions have changed).
To put this into perspective, a leading indicator is what will drive a lagging indicator.
Said another way, by the time the unemployment rate rises, it’s already from old data just now showing up (hence the lag).
This is why it’s important to follow leading indicators – such as the LMCI - as they set the momentum for where the economy is headed.
So, what does the LMCI show us?
Well, it shows a bleak picture. . .
For instance, it’s been decelerating sharply over the last 16 months as the booming post-COVID market cools.

In fact, it’s now below pre-pandemic levels - and the only other times it’s declined like this was before the 2001 recession and 2008 Great Financial Crisis.
- Obviously in 2020 during COVID-19 it fell off a cliff, but let’s ignore random outlier events for this piece.
Now, look at the LMCI (blue line) layered over the U.S. unemployment rate (red line) to highlight the magnitude this leading indicator offers.
As you can see, when the LMCI sinks, the unemployment rate rises in tandem.

Thus, if history means anything – which I believe it does – we can expect a further rise in the U.S. unemployment rate.
The Sahm Rule Is Flashing Red
Next up, let’s look at this relatively unknown but important recession indicator.
I’m talking about the ‘Sahm Rule’.
In short, the Sahm Rule Recession Indicator3 - proposed by Federal Reserve economist Claudia Sahm in 2019 - predicts recessions by analyzing the unemployment rate.
- It signals a recession when the three-month average (3mo avg.) unemployment rate rises by 0.5% or more compared to its lowest average in the past 12 months. Using real-time data, this rule can trigger stimulus programs quickly. Unlike fixed-level rules, the Sahm Rule adapts to changes in demographics, technology, and labor market conditions.
It may sound a bit technical, but what you really need to know is that the Sahm Rule essentially looks at the rate of change in unemployment – which shows the momentum (how fast things are going from boom to bust).
So, what’s the Sahm Rule showing us today?
Well – like the LMCI – it’s not good.
- As you can see in the chart below, the Sahm Rule is at 0.43 – the highest it’s been outside of a recession since 2003,1976, and 1967.

Remember, the logic behind the Sahm Rule is that when the unemployment rate starts rising, it often accelerates, leading to a recession
This tells us that the momentum of the labor market is deteriorating relatively quickly and showing a concerning trend4.
U.S. Job Postings Are Disappearing
Another interesting highlight of a weakening labor market has been the decline in U.S. job postings (those looking for employees).
Looking at the government’s job openings data as well as job postings on Indeed (a worldwide employment website for job listings) shows the demand for labor has steadily continued to decline, approaching pre-pandemic levels. And likely to go lower at this current trend.

This implies two things:
- Companies are seeing a slowdown in demand, therefore reducing expansion in their workforce.
- Employers generally stop bringing on new workers before they begin laying any off.
Thus looking at these three leading indicators - the LMCI, the Sahm Rule, and job postings - we can expect a weaker labor market in the months ahead.
Wrapping It Up
So, it appears things in the labor market are moving in one direction.
And that’s in the direction of not good.
Remember, things move in cycles: up and down, boom and bust, hot and cold.
That’s why it’s important to watch the trend of the labor cycle. And as of now, it looks like things will get worse before they get any better.
And that’s what worries me. Because if the whole economic backbone is based on a “strong labor market” then it looks like the rug is being pulled out from under it.
But in all honesty, who knows where things will go in the future? This is all simply food for thought.
However, it's better to stay informed about what's actually happening.
- In other words, seeing the full picture is crucial for gaining an edge.
So, the next time you hear discussions about the national unemployment rate, you'll have additional insights to share and enlighten others with.
Take care.
Sources:
- Consumer Spending | U.S. Bank (usbank.com)
- Unemployment Rate (UNRATE) | FRED | St. Louis Fed (stlouisfed.org)
- The Sahm Rule Recession Indicator Definition and How It's Calculated (investopedia.com)
- Warning: This recession signal if flashing red (yahoo.com)
Disclosures:
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