Australia’s Economic Dilemma & Sahm’s Rule Under Scrutiny

7 min read

Welcome back to our latest edition of Market Insights with Sanjeev Kaushik.

In this edition, we dive into the growing fears of recession, with millennials in Australia feeling the impact the hardest.

We’ll also be taking a closer look at the recent surge in unemployment rates across G10 economies and shining a spotlight on Sahm’s Rule—a recession indicator gaining renewed attention.

Let’s dive in and break down the Sahm Rule to help you decide if this indicator truly holds the key to predicting economic downturns.

So let’s dive right into it..

Today at a glance:

• Middle-Aged Australians Face Economic Troubles
• Can Sahm’s Rule Really Predict Recessions?
• When Recessions Begin and End?

1. Middle-Aged Australians Face Economic Troubles

Australia is in the midst of what could be dubbed a “Millennial Recession”, with weak household consumption taking center stage in the country’s economic story.

Recent data from the 2Q2024 National Accounts paints a sobering picture: Year-on-year consumption growth has slowed to just +0.5%, despite Australia’s population booming by +2.5%. Excluding the pandemic, this is the slowest pace of consumption growth since the 2008 global financial crisis.

But what’s really driving this slowdown?

1.1 The Fall in Discretionary Spending

Much of the weakness stems from a drop in discretionary spending, which covers non-essential items like entertainment, dining out, and travel—things we often take for granted during good economic times.

Weak discretionary spending is weighing on consumption in Australia.

According to Goldman Sachs, discretionary spending shrank by -0.5% year-on-year in Q2, or a more striking -2.9% when adjusted for population growth.

The reasons behind this decline are clear. While wages have risen since 2022, higher prices and climbing interest rates have more than offset these gains, leaving households with less disposable income.

Australians are not just facing inflation at the supermarket—they’re also dealing with rising mortgage rates and taxes. Notably, Australia’s tax brackets aren’t indexed to inflation, meaning that people are paying a higher share of their income in taxes, further squeezing their wallets.

1.2 The New Economic Victims

This crunch is hitting younger households the hardest. Millennials, Gen Xers, and even some Zoomers are at the forefront of this consumption slowdown.

These generations allocate 40-45% of their total spending to discretionary items, compared to just 30-35% for Baby Boomers and the Silent Generation. In short, when the going gets tough, younger households have less flexibility to cut back on essentials, forcing them to scale back discretionary spending.

Millennial households have seen the largest declines in incomes over the past two years.

The numbers back this up. Over the past two years, Millennial households have seen their real disposable income fall by a staggering -9.4%.

Gen X isn’t far behind, with a -7.2% decline, while Zoomers have suffered a -6.6% drop. In contrast, Baby Boomers have only experienced a -2.4% reduction, and the Silent Generation is almost flat at -0.6%.

This generational divide in income and spending power is central to understanding the current weakness in Australia’s consumption-driven economy.

1.3 What Does This Mean for the Future?

Looking ahead, the outlook for consumption growth remains bleak.

Goldman Sachs has revised down its forecast for aggregate consumption growth to 0.9% in 2024 and just 1.5% in 2025.

To put that in perspective, the Reserve Bank of Australia (RBA) was previously expecting consumption to grow by 2.4% in 2025.

Goldman Sachs forecasts a gradual rebound in real incomes to support a modest rise in consumption going forward.

The causes for this slowdown are multifaceted. Even though tax cuts and lower interest rates are on the horizon, the recovery in household incomes and spending is expected to be gradual.

High inflation and rising unemployment are dampening consumer confidence, and younger households may continue to feel the pinch as wage growth remains modest. This means that Australia’s economic recovery could be slower than anticipated, with GDP growth also being revised down for 2025 to 2.0%.

1.4 The Role of Monetary Policy

What’s next for Australia’s central bank? Goldman Sachs predicts the Reserve Bank of Australia (RBA) will begin cutting interest rates by early 2025, potentially bringing the cash rate down to 3.25%.

However, with consumer spending weakening and wage growth lagging, the RBA might act sooner. Many economists are closely monitoring the situation, particularly to see if rising unemployment forces the RBA to pivot earlier than expected.

If the labor market softens or economic conditions deteriorate further, the central bank could be pushed to accelerate its monetary easing to support the economy.

1.5 A Recession of Generational Divide

The “Millennial Recession” isn’t just about sluggish numbers—it’s a story about how different generations are navigating today’s economic challenges. While older households benefit from rising interest receipts and government transfers, younger Australians are grappling with higher taxes, soaring living costs, and fewer discretionary dollars.

As we head into 2025, the economic recovery looks to be a long and slow journey, with Millennials and Gen Xers at the frontline of Australia’s consumption downturn. The question remains: Will tax and rate cuts be enough to turn the tide, or are we witnessing a longer-term shift in spending habits and economic behavior across generations? Time will tell, but for now, the Millennial Recession is in full swing.

Can Sahm’s Rule Really Predict Recessions?

Recent increases in the unemployment rate across G10 economies have reignited discussions about Sahm’s Rule as a potential recession indicator.

2.1 What is Sahm Rule?

Sahm’s Rule is a recession indicator developed by economist Claudia Sahm. It uses changes in the unemployment rate to identify the onset of a recession.

Specifically, Sahm’s Rule states that if the unemployment rate rises by 0.50 percentage points or more relative to its low over the previous 12 months, it signals that the economy has entered a recession.

While Sahm’s Rule has demonstrated a high level of accuracy in predicting recessions in the US—reportedly 100% accurate—its effectiveness diminishes when applied to other developed markets (DMs), where accuracy is estimated to drop to around 70%.

Learn more about Claudia Sahm’s work here: Macromom Blog

2.2 Is Sahm’s Rule Reliable After All?

2.2.1 Accuracy Across G10 Economies

Sahm’s Rule has demonstrated high reliability as a recession indicator in the US, consistently flagging recessions with notable accuracy. However, its performance varies when applied to developed markets outside the US.

“The accuracy of Sahm’s Rule diminishes in these regions due to differences in labor market dynamics and economic structures, which impact its effectiveness.”

2.2.2 Labor Market and Economic Indicators

Historical analysis of Sahm Rule triggers across developed markets indicates that the rule accurately signals a recession when accompanied by significant slowdowns in employment growth, labor force growth, and overall economic activity relative to long-term trends.

Among these factors, a notable slowdown in employment growth is identified as the most reliable predictor of the rule’s accuracy. Although recent increases in unemployment have been observed, employment growth in most developed markets remains relatively robust, suggesting that the Sahm Rule might not be as effective in these conditions.

2.2.3 Recent US Unemployment Trends

The recent upticks in the US unemployment rate, while noticeable, do not align with the broader economic indicators that historically correspond to Sahm’s Rule recessions.

The current data dashboard more closely resembles past scenarios where the Sahm Rule resulted in false alarms rather than confirming actual recessions. This suggests that the rise in unemployment alone is unlikely to signal an imminent recession in the US.

2.2.4 Implications for Policy Rates

Historical trends show that deterioration in labor markets often precedes a shift toward more dovish monetary policy, including interest rate cuts. While the recent increase in unemployment does not by itself indicate an imminent recession, it could influence policy adjustments in the near future.

This potential shift may affect baseline policy rate forecasts, suggesting that central banks might adopt a more accommodative stance in response to evolving labor market conditions.

When Recessions Begin and End?

Markets falter, spending shrinks, and uncertainty takes over.

But what if I told you that understanding the beginning and ending of a recession isn’t as straightforward as it seems?

Brace yourself for Sanjeev’s Guide to Recession – where the twists and turns of economic cycles come to light.

Watch the video now and discover how recessions truly unfold, from the very first signs to their final moments.