Why Unemployment Rising in States Like California and New Jersey Isn’t a Problem for the US Economy

The US labor market has remained resilient since the start of the year, but there are signs of some cracks forming underneath the surface.

The unemployment rate has been picking up in states across the country. Or, more accurately, on either side of the country.

In California, for instance, the state unemployment rate hit 5.3% in February, up 0.8% from a year ago and the highest in the nation. New Jersey's unemployment rate hit 4.8% in February, also up 0.8%. And this as the national unemployment rate ticked up to 3.9% in March.

This uptick in unemployment has triggered the so-called Sahm Rule in 20 states, including California, New Jersey, New York, and Illinois, kicking off a discussion about whether recessionary signals are being sent underneath some of this year's strong headline economic data.

The Sahm Rule, developed by economist Claudia Sahm, shows that the US economy has entered a recession if the three-month average of the national unemployment rate has risen 0.5% or more from the previous 12-month low.

Sahm told Yahoo Finance in an interview these state-level triggers highlight the "growing risk" of restrictive Federal Reserve policy on the health of the labor market.

But, Sahm added, "this is not a five-alarm fire" and upticks in state unemployment using the Sahm Rule aren't a valid indicator of a national recession.

On a national basis, the average three-month unemployment rate was up less than 0.3% in February compared to the previous 12-month low, well below the level that would trigger the Sahm Rule.

Immigration surge

At 3.9%, the unemployment rate as of February stood at its highest level since January 2022.

But the national and state unemployment data is telling a story that might not be all bad for overall economic growth.

On a national level, economists have been highlighting the unexpected increase in immigration in recent years as part of the reason why certain economic data points have surprised to the upside.

In the aggregate, additions to the population have fueled further demand from consumers and helped employers fill vacant jobs, thus increasing the labor force and output from companies.

Sahm points out this trend can also be found at the state level.

Three of the largest states that have seen an increase in unemployment — California, New Jersey, and New York — have also seen immigration booms. Sahm notes that these workers often have a "legitimately harder" time finding jobs, which would explain why state unemployment could increase as the new employees search for work.

Economists saw this influx of labor supply as one of the "good reasons" for unemployment rate increases in August 2023.

"It's a positive really in terms of the economy, in terms of labor shortages, it is a positive story," Sahm said. "And it often is with immigrants."

Other economists have also recently highlighted that if unemployment is picking up in part because the overall labor supply is increasing, that isn't necessarily a bad thing for the overall economy.

"When considering these higher population estimates, the direction of travel seems clear — stronger employment and GDP growth than previously anticipated," Morgan Stanley economist Sam Coffin wrote in a research note on March 28.

"It also means that while the labor market remains strong, labor supply and demand are in better balance today than previously thought, leading to more upside risk for the unemployment rate should supply begin to outstrip demand."

'Too noisy'

Still, a triggering of the Sahm Rule at the state level has caught the attention of Wall Street economists who have, by and large, been too conservative in forecasting the US economy in recent months.

UBS chief US economist Jonathan Pingle said in a client note on March 29 this level is "unseen unless in or directly around a recession." Pingle also highlighted that 20 states triggering the Sahm Rule represents a substantial increase from just two states triggering the rule in February 2023.

"Calculated on a state level, it may or may not augur national weakness to come, but it does suggest that the distribution of economic resilience may not be evenly spread about the country," Pingle wrote.

"The tricky thing is, is there's almost certainly moderation happening," Sahm told Yahoo Finance.

"So not all of that increase in the unemployment rate is going to be a good thing...But it's not all a bad thing because there are clearly some dynamics of immigration [increasing] and the state data just reinforces it."

Sahm also notes, however, that state reports can simply be "too noisy" and volatile. Moreover, her rule was never tested on a state-by-state basis. She said this number would likely be different for each state, as seasonality in labor activity for certain states isn't accounted for, nor is the recent increase in immigration.

And, should the economy actually tip into recession, all states would be flashing red anyway.

"The states [would] all have this increase in the unemployment rate when the US goes into a recession because recession is a broad-based contraction," Sahm said. "So you're gonna see contractions in labor markets across the country."

Josh Schafer is a reporter for Yahoo Finance. Follow him on X @_joshschafer.