Friday's Bureau of Labor Statistics July jobs report could indicate whether the U.S. economy is trickling into recessionary territory, according to a closely watched indicator.

The Sahm Rule: The Sahm Rule, devised by economist Claudia Sahm, is a heuristic measure used by the Federal Reserve to determine whether the U.S. economy is in a recession.

The Sahm Recession Indicator signals the start of a recession when the three-month moving average of the unemployment rate rises by 0.5% or more relative to the minimum of the three-month averages from the previous 12 months.

Essentially, the indicator tracks increases in employment which are likely to persist and accelerate. Historically, the rule has correctly predicted every recession since 1950 with only one false positive in 1959 (though a recession came the next year).

Friday's Report: The Sahm indicator reached 0.43% in June, according to the Federal Reserve Bank of St. Louis. This is dangerously close to the 0.5% threshold. Unemployment was 4.1% in June.

If unemployment rises to 4.2% in July, it will trigger the Sahm rule. Investors on the betting market Kalshi give such a result a 32% chance.

Sahm herself is dismissive of her rule's implications this go around.

"A recession is not imminent, even though the Sahm rule is close to triggering," she wrote on her blog on July 26.

Sahm believes that unusual patterns in post-COVID-19 employment and immigration is "overstating" the labor market's weakening. She does believe recession risk could necessitate the Federal Reserve to cut interest rates.

Why it Matters: The Federal Reserve will meet on Wednesday to set future interest rate policy. According to CME FedWatch, the market is only giving a 4.1% probability of a July interest rate cut. Investors are more hopeful that the Fed will cut rates later this year.

FedWatch shows investors pricing in two to three rate cuts by the end of 2024.

Since raising rates in 2022 and 2023, the Fed has played a careful balancing act of cooling down the economy while not inducing a recession.