The creator of a famed recession indicator says the Fed is 'playing with fire' by not cutting rates now

• Economist Claudia Sahm says the Fed needs to gradually start cutting rates now to avoid a contraction.
• She is the creator of the Sahm Rule, a labor-tracking recession gauge.

The Federal Reserve's reluctance to lower interest rates in the near term is a risky gamble that could drive the US towards a recession, Claudia Sahm told CNBC.

The former Fed economist said the central bank is "playing with fire," as its insistence on keeping rates higher drives a worrying tick up the "Sahm Rule" — a recessionary indicator created by and named after her.

"My baseline is not recession," she said. "But it's a real risk, and I do not understand why the Fed is pushing that risk. I'm not sure what they're waiting for."

For their part, officials have explained the wait on an inadequate amount of disinflationary data. Many central bankers prefer to know that inflation is on a clear path down towards the target 2% rate. At current readings, that likely means just one rate cut in 2024, the Fed said.

But by keeping rates at 5% highs for nearly a year now, the Sahm Rule is inching closer towards its recessionary threshold.

The model tracks unemployment's three-month average rate; once this moves 0.5% up from a 12-month low, it's a near-certain sign the US is in a contraction.

The gauge now stands at 0.37, after last month's jobless rate pushed past 4% for the first time since early 2022. That's the highest it's been since a Covid-era peak.

For this reason, Sahm told CNBC that the Fed should start a gradual cutting cycle now, and take the economy off a path that could require more severe action if not addressed.

"The bad outcomes here could be pretty bad," she said. "From a risk management perspective, I have a hard time understanding the Fed's unwillingness to cut and their just ceaseless tough talk on inflation."

Others have also joined calls for more immediate cutting, such as top economist Mohamed El-Erian. Similarly, he noted that a delayed cut could require the central bank to have to enact a more drastic easing cycle, as the economy slips into a heavy decline.

Markets, meanwhile, remain convinced that the Fed will follow with more than just one cut. Investors are indicating at least two 25-basis point reductions starting in September.