Staying Sanguine About the Horizon

Thank you for that kind introduction, and for having me here. I thought today I could share my perspective on the U.S. economy and where it may be headed. But I’m just as interested in learning from your questions and comments. As always, the thoughts I share are mine alone and not necessarily those of anyone else on the Federal Open Market Committee (FOMC) or in the Federal Reserve System.

About 30 years ago, I participated in an outdoor team-building program designed for executive development. One of our tasks was to climb up a telephone pole and then stand on top of it. You might wonder what that has to do with team building. I was younger then but still didn’t run to the front of the line. Instead, I watched colleague after colleague climb the little metal pegs on the side but then lose their balance as they tried to climb off the last peg and stand on the top of the pole. They had harnesses, don’t worry.

It was windy, and the pole was swaying ever–so slightly. Every time someone looked down to push themselves up, they saw the movement and lost their nerve. In time, some figured out the trick: Keep your eyes on the horizon. If you didn’t focus on the pole swaying and the ground seemingly moving, you could stand with confidence.

This story came to mind as I was thinking about the economy. It fits what I see. The ground may look shaky on both sides of our mandate, causing some to stress that the economy will lose its balance. But if you focus on the horizon, the path forward feels more stable. So, let me take each part of our mandate in turn. I’ll talk about what looks shaky and then give you my case for why you shouldn't lose confidence.

Downward Pressure on Employment

Let’s start with the labor market. For the last six months, I’ve been describing businesses as trying to “drive through fog.” With uncertainty so high, it’s hard to put your foot on the gas or to step on the brakes. They’ve felt no choice but to pull over with their hazards on. They haven’t been cutting back, but they also haven’t been leaning in. They’re not firing, but they’re also not hiring — instead they’re cautiously downsizing through attrition.

This sustained caution has put downward pressure on employment. As I’m sure you’ve seen, recent job growth numbers have been low, with the three-month average coming in at just 29,000. The hiring rate is near its Great Recession lows. The unemployment rate has ticked up to 4.3 percent.

Beyond the numbers, it also seems there has been a noticeable shift in the labor market. If you ask businesses how they see that market today, they say, “balanced.” But as they describe that “balance” in more detail, it doesn’t seem so. With the exception of skilled trades, labor feels quite available with plenty of quality applicants per opening. I have been particularly struck by two food processors who each lost hundreds of employees to the revocation of temporary protected status and yet were able to backfill those positions with little difficulty. These aren’t the most attractive jobs, to say the least. If they can be replaced with short notice, that’s a sign that the labor market has started to seem a little wobbly.

But, with that said, if you look toward the horizon, there are reasons to be more sanguine.

First, labor supply is shrinking at about the same rate as labor demand. Border crossings have plummeted, with some estimates that immigration will be down by over 2 million this year. Hundreds of thousands are expected to lose temporary protected status. And my generation, the baby boomers, continues to age (even though I haven’t). Over the past three years, the number of people over 65 and out of the labor force has increased by an average of 1.3 million a year. There may be fewer jobs to fill, but there are also fewer people vying for each job. The data reflects this: While job growth has fallen considerably, the unemployment rate has stayed relatively stable.

Second, demand remains solid and could even get a boost from stimulus embedded in the recent tax bill. After they hunkered down in the spring, recent data show consumers resumed spending over the summer, especially those with higher incomes. And why wouldn’t they? Unemployment is still low, nominal wages are still increasing, and asset valuations are near all-time highs.

The underlying dynamics for businesses remain healthy too. Of course that differs by sector, with data centers and power generation booming and residential and agriculture struggling. Second quarter earnings were strong, and stock prices keep climbing. Uncertainty seems to be coming down as the path for government becomes clearer. Our recently released CFO Survey, which we run in collaboration with the Atlanta Fed and Duke University, found that business optimism has ticked back up near the levels they hit at the end of last year, the highest since 2021. All of that bodes well for the economy.

But even if demand were to weaken, I doubt we’d find companies as overextended as they have been before the downturns we remember. Businesses have been cautious for years now, in the wake of interest rate hikes, premature recession forecasts and more recently, policy uncertainty. After years of low hiring, they should have fewer extra workers and therefore be less likely to need to resort to sizable layoffs.

Net that means the downside in the labor market should be limited.

Upward Pressure on Inflation

So, let’s turn now to inflation, where I see a similar dynamic.

Inflation remains above the Fed’s target at 2.7 percent. Core inflation is at 2.9 percent, with the monthly increase at 2.8 percent annualized in August. Inflation has now been over target for 4 1/2 years.

And we know tariffs are affecting input costs (as are other costs like rising health insurance premiums). For months, businesses have been giving reasons why prices do not yet reflect tariff passthrough. They point to transit time, to inventory buildup, to longer-term contracts. But, while the impact may be delayed, they are clear they plan to pass on what they can over time. In the context of inflation already above target, that can make the outlook for inflation seem shaky as well.

But, again, I’m more sanguine looking at the horizon.

For one, price-setters seem reluctant to make price increases too visible. Nobody wants too much attention. Additionally, productivity growth seems to be improving significantly. Employers who got caught short a few years ago invested in automation and new processes to reduce their dependence on labor. Deployment of new technologies like artificial intelligence, or AI, is having an impact, particularly on coding, call centers, and entry-level employees. And businesses reluctant to hire are finding ways to get work done with less. Higher productivity growth helps offset margin pressure in a way that limits inflation — as we saw in the second quarter, when earnings grew despite higher costs and limited price passthrough.

And, perhaps most fundamentally, while consumers are still spending, this isn’t 2022. Consumers aren’t as flush with excess savings; they are making choices. They are trading down, repairing rather than replacing, and moving to private brands and value retailers. They may also be trading off: funding frontloading of, say, an iPhone by cutting back on a vacation. Consumer pushback should limit the magnitude of price increases.

So, the ground may look shaky today, but there are good reasons to think countervailing forces will limit the downside. I would note, though, that the numbers may look a little unusual during this period. GDP growth could slow as population growth stalls, without triggering a tick up in unemployment. Job growth numbers could look low, while unemployment stays relatively stable. The mix of relative price changes across categories could shift.

Striking Balance with Monetary Policy

Since 2022, with inflation above our target and the labor market healthy, it made sense for us to focus our attention on inflation. You could say we were climbing the pole at that point. The direction was clear: You follow the pegs up. Now, with inflation risks still elevated but the downside risks to employment rising, we face a more challenging situation. We are at the top of the telephone pole, if you will. With our two mandate goals in tension, our focus is more about balance.

At our last meeting, we cut the federal funds rate by 25 basis points to just over 4 percent, moving toward a more neutral policy stance. This should help support the labor market while maintaining pressure on inflation, in the interest of keeping the economy on path to that more stable horizon.