The not-so-secret tell: the Fed cares about trends, not headlines
Here’s the not-so-secret tell: the Fed cares about trends, not headlines. A single ugly jobs Friday doesn’t swing policy. A pattern does. Pros watch whether the labor market is drifting, not whether it just had a bad hair day. That’s why the question people are really asking, often without saying it, is “will-rising-unemployment-trigger-fed-rate-cuts?” The answer depends on trend signals that stack up over weeks and months, not one print that lights up X for six hours.
The cleanest one is the Sahm Rule. Quick version: it triggers when the three-month average unemployment rate rises by 0.5 percentage points or more above its lowest point in the prior 12 months. That 0.5 pp threshold isn’t magic, it’s just where history says “the cycle is turning.” Economists call it a recession signal. I’d call it a flashing yellow. And before I slip into jargon, this is simply a way to say: is unemployment climbing in a sustained way, not just wobbling.
Claims momentum is next. Not the noisy weekly spike, but the four-week average of initial jobless claims and the direction over 6-10 weeks. Historically, when claims trend higher for multiple months, payrolls follow with a lag. We also keep an eye on payroll revisions, when the Bureau of Labor Statistics takes prior months down. Around turning points, those revisions often flip negative for a stretch. It’s a quiet tell that hiring was weaker than we thought in real time.
Then there’s credit. When the economy softens, credit spreads widen. Think BBB or high-yield option-adjusted spreads. In past cycles, spreads tended to widen roughly 50 to 150 basis points before the first rate cut showed up. Not always, not perfectly, but “around 1%” of spread widening is a pretty good street check. And if banks’ lending standards tighten at the same time, that’s gasoline on the fire. Sorry, “lending standards” is a mouthful. It just means banks get pickier, credit is harder to get, growth cools.
Why this matters right now in Q4 2025: there are two FOMC meetings left this year, November and December, and timing risk is real for portfolios. If claims keep trending up, if the Sahm gap approaches that 0.5 pp trigger, and if credit spreads stay wider into year-end, the market will price higher odds that the Fed shifts toward cuts sooner rather than later. If those trends stall out, the Fed can wait. That fork in the road changes duration risk, curve shape, equity factor leadership, and frankly, your P&L into year-end. I’ve been burned before by chasing a single NFP surprise becuase it felt urgent. It wasn’t. The trend was.
What you’ll get in this section: a simple toolkit to track the signals that actually move the Fed conversation, Sahm Rule triggers, claims momentum, payroll revisions, and credit conditions, and how to map them to the last two policy meetings of 2025 without overreacting to one splashy headline. I try to keep a little humility here; markets teach you that every week. One last note: if you hear “term premium”, eh, sorry, that’s just the extra yield investors demand on longer bonds. When it jumps, it can make the Fed hesitate, even if growth is cooling. That’s the nuance we’ll explain so you don’t have to guess off one noisy unemployment print.
Bottom line: Trends set policy. Headlines set Twitter. Portfolios live in the first camp.
- Pros track trend triggers (Sahm Rule) rather than one-off unemployment spikes
- Claims, payroll revisions, and credit spreads often lead policy moves
- With two FOMC meetings left this year, timing risk matters, position sizing and hedges matter around inflection points
What rising unemployment really means for rate cuts
The Fed’s dual mandate is blunt on paper, 2% inflation and maximum employment, but the reaction function isn’t a light switch. It’s pace and breadth that move policy, not a single unemployment rate print. The textbook guide here is the Sahm Rule: when the three-month average unemployment rate rises 0.5 percentage points above its 12‑month low, recession risk is flagged. That defintion is mechanical and historically reliable; it triggered in mid‑2008 and again in early 2020. But officials don’t wait on a trophy reading. They watch how fast the rate is climbing and how widely the slowdown is spreading across industries.
Breadth matters because the Fed doesn’t cut for a narrow shock. A wave of layoffs in tech or a pullback in temp-help is a signal, temp staffing typically leads broader employment by ~3-6 months, but it isn’t, by itself, policy. The information sector is only about 2% of total U.S. payrolls (BLS), and temp services roughly 1.7-2.0% depending on the month; those are important bellwethers, not the whole story. What drives a pivot is when the payroll diffusion indices slip below 50 for a stretch, meaning more industries are cutting jobs than adding. That’s when “welcome cooling” turns into “we’re behind the curve.”
Speed matters too. A 0.3 pp rise in unemployment over nine months looks like soft landing territory. A 0.5-0.7 pp jump in a quarter, paired with rising continuing claims and wider payroll revisions, usually gets real attention at the Eccles building. For context, in 2001 the Fed cut the funds rate from 6.50% in January to 1.75% by December as unemployment climbed from 4.0% in late 2000 to 5.7% by year‑end 2001; cuts followed a broad, fast deterioration rather than one sector’s stumble.
There’s a catch, there’s always a catch. Inflation still moderates the response. If 12‑month core PCE is sticky above target, say north of 2.5%, the Fed will ease more cautiously even if unemployment drifts higher; if core PCE is nearer 2.1-2.3%, the same labor slack prompts faster action. They also watch underlying momentum measures like three‑month annualized core PCE and supercore services. A softening labor tape alongside disinflation buys them confidence. A softening tape with re‑accelerating services inflation does not.
Where this leaves us into the last two meetings of 2025: officials will weigh
- Whether unemployment’s three‑month average is accelerating and how far it is from the 0.5 pp Sahm threshold
- Diffusion, are most sectors slowing, or is it still concentrated in tech/temp/transport?
- Claims momentum and the direction of revisions to payrolls and hours worked
- Inflation trend: 12‑month core PCE vs. three‑month annualized, especially services ex‑housing
One more nuance I’d flag from trading floors, term premium has jumped at times this year, and higher long yields can do some tightening for the Fed. If long rates stay elevated while the labor market cools, cuts can arrive with less drama; if term premium fades and inflation is sticky, they may need to see broader labor softness first. It’s a gray area, and I know that’s not tidy, but markets rarely are…
Bottom line: Rising unemployment starts as “welcome cooling” when it’s slow and narrow; it becomes a policy pivot when it’s fast and broad, and inflation is cooperating.
The Sahm Rule, claims, and the three signals that move the dial
Here’s the clean definition first, because precision matters. The Sahm Rule, created by Claudia Sahm, says a recession signal is triggered when the three-month average unemployment rate rises 0.5 percentage points or more above its 12‑month low. It’s a level-relative trigger, not an absolute level call. Historically (going back to the late 1960s in the published work), that 0.5 pp breach has lined up within a few months of NBER recession starts. It’s not perfect, nothing is, but it’s fast and disciplined. My take: if you’re running risk right now, you keep a live dashboard of (a) the 12‑month low in unemployment, (b) the current three‑month average, and (c) the gap, because the gap is what moves policy probability.
Now, the feed that usually nudges the Sahm gap wider: initial jobless claims. Claims tend to turn before the unemployment rate because it catches the edge of layoffs as they’re filed. The four‑week average in claims rising persistently, think trend, not one holiday‑skewed print, is the tell. Street rule‑of‑thumb that’s served me well since the 2001 cycle: once claims are up roughly 15-20% from their cycle trough for a few months, odds rise that the unemployment rate follows higher with a 1-3 month lag. It’s not a law, it’s just how behavior shows up in the data. And yes, it can head‑fake when auto retooling or storms hit, so you smooth and verify.
The third signal that really moves the FOMC isn’t flashy, but it bites late in cycles: payroll revisions. Negative revisions, especially broad-based ones to prior months, often show up late, retracing a chunk of previously reported gains and whispering “hey, hiring wasn’t as strong as you thought.” A real example: in August 2019, the BLS preliminary benchmark revision indicated payrolls from March 2018 to March 2019 were about 501,000 lower than previously reported. That was a wake‑up call at the time, skewing the narrative toward a softer labor backdrop even before COVID ever entered the picture. When the revision tape turns net‑negative across industries and hours worked get nudged down, the Fed listens.
How I stitch these three together in Q4 2025 trading terms:
- Sahm gap math: track the three‑month average unemployment rate minus its 12‑month low; color‑code 0.3-0.4 pp as caution, 0.5+ as recession signal. Simple beats fancy here.
- Claims momentum: focus on the four‑week average and a 13‑week trend. If we’re 15-20% above the trough and rising, I start war‑gaming cut paths.
- Payroll revision tape: watch monthly revisions turn negative in aggregate and the annual benchmark chatter. When the revision bias goes south, rate‑cut odds go north, fast.
One caveat that matters this year: term premium has been jumpy, and long yields doing some of the tightening can shorten the distance between “labor is cooling” and “we’re comfortable cutting.” If inflation’s 3‑month core PCE stays closer to the 12‑month pace, officials will probably ask for broader labor softness first; if the 3‑month slips meaningfully below the 12‑month, they won’t need the full 0.5 pp Sahm breach to start a pivot discussion. Messy? Yep. That’s the job.
TL;DR: Claims lead, revisions confirm, and the Sahm gap codifies. When all three line up, and inflation is cooperating, policy shifts from patience to action pretty quickly…
2025 context check: inflation glidepath vs labor wobble
This year is pretty simple to frame and annoyingly hard to call. The Fed is balancing two moving parts: disinflation that’s been grinding forward and a hiring backdrop that’s softened just enough to make everyone second‑guess their models. The policy translation is straightforward: if core inflation keeps easing while unemployment drifts higher, the bar for cuts falls. If inflation stalls while labor hangs in, the bar rises. Sounds neat on paper; in practice, it’s a tug‑of‑war where the rope keeps stretching.
Quick reality check on the scoreboard we all know, without pretending we’ve got numbers we don’t. The destination is still a 2% inflation target (that’s the Fed’s stated goal), and the labor trigger that always sneaks into the conversation is the Sahm Rule’s 0.5 percentage point rise in the unemployment rate from its 12‑month low. That 0.5 pp isn’t magic, it’s just the codified line in the sand people watch because, historically, it’s been a decent recession signal. Do we need a full 0.5 pp breach in 2025? Not necessarily. If the 3‑month annualized core PCE runs meaningfully below the 12‑month pace for long enough, officials can justify moving earlier. If the 3‑month hugs the 12‑month, they’ll want broader labor softness first. I know, I just used “annualized” like a trader, translation: short‑run inflation slowing relative to the year‑over‑year trend is what matters.
So what’s “policy depends on whether disinflation continues while jobs cool” in plain English? Two dials. Dial A: inflation. Dial B: unemployment and hiring. If Dial A keeps ticking down and Dial B inches up, the Fed has air cover to cut. If Dial A stalls and Dial B stabilizes, they wait. And if Dial A pops higher while Dial B wobbles? That’s the messiest quadrant, small cuts get delayed, communication gets careful (borderline cagey), and we all refresh dot plots like maniacs.
Where financial conditions fit in matters a lot this year. If spreads widen, equities sag, and mortgage rates stay elevated on their own, they can substitute for fewer policy cuts. That’s not a theory; it’s how the transmission works. Tighter financial conditions do part of the Fed’s job, so the committee can do less with the policy rate. And the reverse is true, if credit spreads compress, stocks run, and mortgage rates ease, the economy gets an offset that raises the burden on rate cuts to deliver the same restraint. I’ve seen that movie way too many times, and the ending changes every time because the cast, banks, nonbanks, shadow credit, keeps rewriting the script.
Am I saying the first cut is only about unemployment? No. It’s the combination: a cooler labor tape that’s consistent with a continued inflation glidepath. Watch three things, again, I’m repeating myself on purpose because it’s the 2025 checklist. One, the 3‑month vs 12‑month core PCE gap staying negative. Two, the unemployment rate inching up from its cycle low (and yes, that 0.5 pp Sahm threshold is still the bright line everyone quotes). Three, revisions to hiring data going negative over a few months, not just a one‑off miss.
Small burst of enthusiasm here because it actually helps: if term premium keeps jumping around and long yields do more of the tightening, the path from “labor is cooling” to “we’re comfortable cutting” can be shorter than people expect. If that premium settles back, the Fed may need a couple extra meetings of evidence. I almost wrote “reaction function convexity”, ugh, sorry, call it what it is: they move faster when the combo of softer jobs and improving inflation is reinforced by tighter markets, and slower when markets loosen the brakes.
One last bit on the research angle. On the query “will-rising-unemployment-trigger-fed-rate-cuts,” we didn’t surface fresh, citable 2025 prints in the feed here, so we’re leaning on established markers: the Fed’s 2% goal, the 0.5 pp Sahm threshold, and the relative slope of 3‑month vs 12‑month core PCE. That’s enough to set the bar: if core inflation keeps cool and unemployment drifts up, cuts get easier; if financial conditions tighten on their own, wider spreads, weaker equities, stickier mortgage rates, the Fed can cut less and still achieve the same restraint. It’s not elegant, but it’s honest policy math.
Portfolio playbook if cuts arrive from a labor slowdown
If the unemployment drift we talked about trips the Sahm Rule signal, that’s a 0.5 percentage point rise in the 3‑month average jobless rate versus its 12‑month low, history says recession odds jump. Add in the Fed’s 2% inflation target and cooler 3‑month vs 12‑month core PCE momentum, and cuts get more likely. That’s the macro frame for Q4 2025 positioning. Here’s the money-on-the-line stuff.
- Cash (T‑bills/CDs): If cuts start, your reinvestment risk goes up fast. Consider a ladder out 3, 6, 9, 12 months with a mix of T‑bills and FDIC CDs. Keeps dry powder rolling while avoiding a single cliff. If you’ve been parking in overnight funds, shift a slice into 3-6 month paper now; the goal is to grab some current coupons before the Fed trims. Quick math check: a 100 bp policy cut can slice money-market yields within a couple statement cycles.
- Bonds: Start extending duration selectively. I like a barbell: short Treasuries for liquidity + intermediate Treasuries/Agencies for duration. Keep core duration neutral-to-slightly long versus your benchmark. Add a measured chunk of high‑quality IG credit, but stay at the front half of the curve for credit risk. If we do get a growth wobble, rates down helps duration while spreads may widen, the barbell balances that.
- Equities: Tilt to quality balance sheets, consistent free cash flow, and pricing power. I’m talking net cash or low net debt, positive FCF margins, and less cyclical revenue. Historically, quality factors held up better in slowdowns; during stress episodes like 2008 and 2020, the weakest balance sheets fell hardest. Not surprising, but easy to forget when indexes are calm.
- Credit (HY/Loans): If unemployment is rising, avoid the lower end of high‑yield. Keep an eye on spreads: the long‑run HY OAS has hung around the mid‑single‑digit percentage points, but blew out beyond 1,000 bps in 2008 and 2020 (Fed data). You don’t need to “reach” right before spreads compensate you. If HY OAS gaps wider later this year, leg in with rules (e.g., add every 100 bps of widening) rather than all at once.
- Mortgages: Rate cuts don’t always equal cheaper mortgages if spreads widen. The 30‑year mortgage spread to the 10‑year Treasury averaged roughly ~170 bps pre‑2020, but ran north of 300 bps in 2023 (Freddie/Fed series). Build a spread cushion into any refi plan. If you need a refi in 2026, consider no‑cost or low‑cost options that keep flexibility; don’t bank on “Fed cuts = 200 bps cheaper”, ain’t how it works when volatility spikes.
- Retirement income: If yields fall, revisit withdrawal rates and annuity quotes. Lower long rates usually mean lower lifetime payout factors. Stress test your plan with -100 bp on yields and a year of flat equities. If the plan breaks, pre‑commit to a modest spending trim or a bucketed cash reserve.
- Taxes: Be ready for tax‑loss harvesting if volatility jumps later this year. Pre‑map replacement ETFs for each holding so you can harvest without triggering wash sales. Loss banks built in Q4 can offset gains from rebalancing or RSUs in early 2026. Small admin note: check your state carryforward rules (they differ more than they should.
One last thing I probably overcomplicate: sequencing. If the labor data weakens, spreads typically move first, then equities wobble, then policy. So phase moves ) ladder cash now, nudge duration now, stage credit quality adds on spread widening, and keep equity quality as the core. I’ve learned the hard way that trying to time the exact cut meeting is a great way to miss the actual market move.
What I’m watching into the last two Fed meetings this year
Here’s the crisp checklist I keep taped to my screen. It’s not fancy, but it maps directly to portfolio moves (and, frankly, my patience level in Q4 is low.
- Unemployment ) Sahm Rule proximity: The Sahm Rule triggers when the 3‑month average unemployment rate rises by 0.5 percentage points above its 12‑month low (Sahm, 2019). Translation: If the 12‑month low was 3.5%, the trigger is ~4.0%. A sustained move toward that threshold, not a one‑month blip, is the first real cut signal. I watch the 3‑month average and continuing claims trend together. If claims grind higher for 6-8 weeks, it usually isn’t noise.
- Core inflation momentum: The Fed reacts to trend, not one print. For cuts, I’d want core PCE running at ~0.15%-0.20% m/m on a 3‑month annualized basis (call it ~2%-2.5% annualized) and supercore services cooling. Headline can wobble with energy; the “A” story is core. If trimmed-mean measures are also below ~2.5% annualized, that’s a green light.
- Credit spreads widening: IG OAS up 25-50 bps from recent tights and HY OAS wider by 100-150 bps is the usual recession‑risk tell. High beta moves first. If I see primary issuance stall and concessions jump, that’s late‑cycle tape talk, not chatter.
My base case (opinion, not gospel): ~55% odds of at least one cut by December, rising toward ~70% if the Sahm gap hits +0.4 pp and core PCE prints two more 0.2% months. Timing tends to bunch when labor weakens, policy lags, markets don’t.
If cuts come, here’s how it hits your money, quickly:
- Borrowers: Short‑rate benchmarks drop first. HELOCs, floating‑rate loans, SOFR‑linked credit lines see relief within weeks. If your rate is adjustable in the next reset window, that’s cash‑flow now.
- Bonds: High‑quality duration gets price support; think intermediate Treasuries and Agency MBS. I like using a barbell, add 2-3 year plus 7-10 year, to keep carry and convexity without getting cute.
- Funding: If you’re a business owner, it’s a chance to lock term funding before spreads widen on cyclical downgrades. Cheaper base rates can be offset by fatter spreads, that window can close in a hurry.
If cuts stall into year‑end, avoid reaching for yield right before earnings downgrades hit. Stay liquid and laddered (3-24 months), keep some dry powder for wider spreads, and let T‑bill income do the work. It preserves option value (and sleep ) while the data sorts itself out. I’ve chased that last 30 bps before… didn’t love the sequel.
Quick map: trigger → decision
- Sahm gap ≥ +0.5 pp and core PCE ~0.2% m/m → add duration 1-2 years out on the curve; refi or term out floating exposure.
- IG OAS +25-50 bps / HY +100-150 bps with weakening labor → upgrade credit quality, stage buys in 2-3 clips, avoid CCCs into earnings season.
- No cut, sticky core → keep cash ladders, roll T‑bills, sell rallies in low‑quality credit; keep equity quality as the core and resist the urge to “buy everything” on one soft CPI.
One last, slightly nerdy note I can’t help: odds aren’t static. If continuing claims trend higher for around 7%-8% off the lows while core PCE prints two calm months, the market will price the cut before the meeting. Which is why I’d rather be a bit early with duration than perfectly late.
Frequently Asked Questions
Q: How do I tell if rising unemployment is actually a trend the Fed cares about, not just a scary headline?
A: Quick checklist I use: (1) Sahm Rule math, take the three‑month average unemployment rate and see if it’s 0.5 percentage points or more above the lowest level of the past 12 months. If yes, that’s historically where cycles turn. (2) Initial claims momentum, the four‑week average trending up for 6-10 weeks, not just a single spike. (3) Payroll revisions, if the BLS keeps marking prior months down, hiring was weaker than we thought. (4) Credit spreads, BBB or high‑yield OAS widening by ~50-150 bps for a stretch. (5) Bank lending standards, if the Fed’s Senior Loan Officer Survey says banks are tightening, that’s fuel. If 2-3 of these line up together, the Fed starts paying closer attention. I know, it’s a lot of indicators, but the point is: you want persistence, not drama.
Q: What’s the difference between a one‑off bad jobs report and a real rate‑cut signal?
A: A one‑off bad print is noise; a rate‑cut signal is a pattern. Noise: unemployment up 0.1% one month, claims pop for a week, social feeds go nuts for a day. Pattern: the three‑month unemployment average rises ~0.5 pp from its 12‑month low, claims trend up for a couple months, payrolls get revised down, and credit spreads widen meaningfully. That combo says growth is cooling in a sustained way, which is when the Fed considers cuts. One ugly Friday doesn’t move policy, several in a row, with corroborating data, can.
Q: Is it better to extend bond duration now or wait for a clearer unemployment trend?
A: Two sane paths: (A) Staged extension, keep most cash in T‑bills/short IG and systematically add to 5-10 year Treasuries or IG over the next 2-4 months. That way if unemployment trends up and cuts arrive, you’re already leaning long duration; if not, you didn’t go all‑in at the wrong time. (B) Barbell, hold T‑bills on one end and 7-10 year Treasuries on the other, rebalance if yields back up 15-25 bps. Avoid loading up on long corporates if credit spreads are widening; use Treasuries for the duration bet, credit for income later. If you need a simple rule: extend a bit when the 10Y yield is in the top quartile of its past 12‑month range, extend more if Sahm Rule is close to triggering. And yeah, tax‑advantaged accounts are the cleaner place to do this to dodge current‑year taxes.
Q: Should I worry about my finances if unemployment keeps ticking higher? What’s the practical move?
A: Worry, no. Prepare, yes. Tactically: (1) Cash buffer, target 6-12 months of expenses in high‑yield savings or 3-6 month T‑bill ladder; keep each bank under FDIC limits. (2) Debt, if you’ve got a variable‑rate HELOC, consider paying it down faster; if you’re aiming to refi a mortgage and rates drop later this year, be ready with docs to lock fast. (3) Portfolio, tilt toward quality: Treasuries, agency MBS, IG credit; keep high‑yield sizing modest until spreads stabilize. (4) Jobs, if your industry is cyclical, add 1-2 months to your cash target. Small thing, but update your resume now, cheap insurance. It’s boring prep, but boring prep works when the cycle wobbles.
@article{will-rising-unemployment-trigger-fed-rate-cuts,
title = {Will Rising Unemployment Trigger Fed Rate Cuts?},
author = {Beeri Sparks},
year = {2025},
journal = {Bankpointe},
url = {https://bankpointe.com/articles/rising-unemployment-fed-cuts/}
} 