Viewpoint
September 12, 2025 | 14:57
More Gloomy Labor Market Data
Economics
Economics
Economics
Economics
Economics
Economics
Economics
Economics
More Gloomy Labor Market Data |
| The labor market data are getting gloomier, raising the risks of a meaningful slowdown and pushing the Fed toward a more accommodating monetary policy stance even as inflation remains a concern. The New York Fed’s August Survey of Consumer Expectations revealed some important labor market insights. First, we saw a plunge in consumer expectations of finding a job over the next three months to a low 44.9%. This is worse than the pandemic low of 46.2% in December 2020, and 56.0% in October 2024 after the Fed’s bigger-than-expected 50 bp cut (Chart 1). |
| For now, the West and Northeast regions of the country appear to be driving the labor market deterioration. Both saw a big spike in the mean probability of losing their job over the next 12 months, to 19.9% and 16.9%, respectively. In comparison, the Midwest remained relatively stable at 11.8% and the South’s prospects seems to have improved to a low 11.2% chance of losing their job over the coming year (Chart 2). Parsing the data by income bracket revealed lower-income workers (making under $50k a year) are much more concerned about losing their jobs over the coming year than those making more than $50k (Chart 3). These positions are often the first to go during an economic downturn and may be most at risk of automation from AI (Chart 3). The consumer survey data back up the latest BLS employment reports that reveal almost no net nonfarm payroll growth over the past three months and a rising unemployment rate. The preliminary benchmark revision for nonfarm payrolls in the year to March 2025 was a whopping -911k, adding to concerns over labor market fragility (Chart 4). It implies the labor market was on far shakier ground than first reported with average monthly job growth of only around 70k—about half the initially reported pace, even before we received the stagflationary tariff and immigration shocks. If that wasn’t enough to coax the Federal Reserve off the sidelines, initial jobless claims jumped to 263k last week, their highest level since 2021 and above the October 2024 peak that prompted the Fed to cut rates by a full percentage point last year. The difference now, of course, is the outlook for core consumer inflation is deteriorating in tandem and expected to worsen further in the months ahead. Core CPI inflation has accelerated for three consecutive months and jumped to a sizzling 4.2% annualized rate in August. We saw outsized increases in grocery prices, gasoline, rents, apparel, airfare, vehicle prices, and services, squeezing consumers budgets and spending power. Still, we think the rapidly deteriorating labor market trumps lingering inflation concerns in the Fed’s real-time risk management calculus of its dual mandate. So far, tariff-driven global supply chain shocks appear limited, while weaker consumer and business demand ahead should dampen tariff-driven price increases, allowing the Fed to look beyond the latest bout of consumer inflation. The economy appears to be uncomfortably close to an inflection point where a lack of hiring could turn into outright layoffs. Just as it did last year, the Federal Reserve will want to head off any further weakening in the labor market that would force the unemployment rate far higher than already forecast. With the August jobless rate already above the estimated full employment level at 4.3%, there is a narrowing window of opportunity to avoid a hard landing. |
Fed Policy: Resuming Rate Reductions |
| We look for the FOMC to cut policy rates by 25 bps on September 17, with the fed funds target range at 4.00%-to-4.25%. This will resume the rate reduction campaign commenced last September which has been on hold this year. The pause reflected heightened uncertainty surrounding the new Administration’s economic policies, particularly on tariffs. The Fed reckoned a “reasonable base case” was that the effect of tariffs on inflation would be “short lived reflecting a one-time shift in the price level” (Chair Powell), but the net risk was that it could be more persistent. Until recently, solid labor market conditions (acknowledged as recently as the July 30 meeting) afforded the Fed time to wait and see how government policy and inflation unfolded. But since then, the data have weakened considerably. In both July and August, the three-month average growth for payrolls fell under 30k. Apart from 2020, this was the worst short-term trend since immediately after the Great Recession. Meanwhile, the latest unemployment rate (4.3%) nudged above the FOMC’s longer-run level (4.2%) for the first time since October 2021, hinting it could be breaking out of the 4.0%-to-4.2% range registered during the prior 15 months. The recent ‘balance’ between slowing labor demand and slowing labor supply (owing to the crackdown on undocumented workers) could be starting to tip to the former. However, on the inflation front, the core metrics are staying sticky—if not picking up—owing to accelerating goods prices (partly due to tariffs) and stubborn services prices. In August, the three-month change in the core CPI was 3.6% annualized with the yearly pace at 3.1% y/y. In July, for the core PCEPI, the readings were 3.0% annualized and 2.9% y/y. This stickiness is unlikely to prevent the Fed from resuming rate cuts given the labor market weakness, but it will likely keep the cuts gradual. In the Summary of Economic Projections and the ‘dot plot’, we look for the median fed funds forecast to show a second quarter-point rate cut for this year (so two in total for 2025, which was the case in June’s SEP) and probably three moves for next year (it was only one before). And for this to occur against the (median) background of slightly weaker real GDP growth, a slightly higher unemployment rate, and slightly faster core PCE inflation. In the press conference, we suspect Powell will spend time explaining why the Fed sided with the output/employment team in this policy tug-of-war. Note that the September SEP extends the forecast horizon by another year, this time to 2028. This is typically when participants sharpen their projections for 2027. As before, we expect to see another rate cut but with a range midpoint lower at 3.125%. The voting pattern should also be interesting this meeting. Last confab, the tally was 9-to-2 in favour of keeping policy rates unchanged. Governors Bowman and Waller dissented in favour of a 25-bp cut citing deteriorating labor markets. To the extent one, or both, judge that the Fed is now ‘behind the curve’ in avoiding unnecessary labor market slack, either could favour a 50-bp action this meeting. Meanwhile, Governor Kugler was absent in July owing to her forthcoming resignation. Kugler’s seat is expected to be filled by Stephen Miran in time for the meeting. And will Lisa Cook be voting? So, amid the likely decision to cut rates by 25 bps, we’ll probably see at least one dissenting vote in favour of a larger reduction. In the presser, we also suspect Powell will spend time explaining how the Fed is not ‘behind the curve’. |
Inflation Flame Still Flickers |
| The August CPI report confirmed that inflation, while not running away, has heated up this summer. The source of the heat appears two-fold: tariffs, and resilient consumers fueled by a booming equity market. While the report is unlikely to derail a well-telegraphed Fed rate cut next week, it has nearly dashed hopes of a larger move. The report highlighted two concerning developments. First, it showed the largest monthly rise in grocery costs (7.2% annualized) since the bad old days of 2022. Coffee, beef, fresh fruit and vegetables led the surge. With imports accounting for about a fifth of consumed food and beverages, tariffs are likely a contributing factor. Second, core inflation (excluding food and energy) accelerated for a third straight month, rising 0.346%, and pushing the three-month annualized rate to 3.6%. Core services (excluding energy and rents) are flashing 4-handles on a one- and three-month annualized basis. This is partly due to outsized increases in airfares, hotel rates and auto repairs, tempered by a retreat in medical care costs. Core goods prices also picked up for a third straight month, to 3.4% and 2.8% for one and three months, led by appliances, clothing, and used vehicles. While new vehicle prices remain subdued, that may not last as dealers exhaust pre-tariff inventory, pushing some buyers into the used market. The Cleveland Fed’s weighted-median and trimmed-mean measures also suggest that the underlying trend in CPI inflation is running just above 3% annualized. Piling on, the University of Michigan’s five-year inflation expectations metric popped to a three-month high of 3.9% in early September. If there’s any consolation for the FOMC next week, it’s that PCE prices (the Fed’s preferred inflation measure) will likely rise less than the CPI in August. Given subdued medical care costs and some substitution away from costlier tariffed goods, the core PCE gauge is expected to rise a more modest 0.2% following back-to-back 0.3% increases. This should keep the annual rate at 2.9%, two ticks below the comparable CPI print. Still, that’s well above the Fed’s target, meaning there’s some inflationary wood to chop. The question policymakers face in future meetings is: Can weaker labor markets alone do the chopping, or should policy rates remain modestly restrictive to sharpen the blade? |
