What Businesses Are Saying: Demand and Cost Pressures Felt Broader

The Federal Reserve has a dual mandate from Congress: price stability and maximum employment. To better understand how the regional economy is faring on both fronts, we regularly look to our wide network of business and community partners. Through this economic sensing, we gain better insight into what's happening now, and what might come next. In this post, we draw from dozens of conversations with businesses from early August to early September.

Overall Momentum: Was Strong Demand Limited to AI-Related Goods and Services?

Demand held up this past cycle, and it wasn't only because of artificial intelligence (AI). Data centers and their supply chains reported remarkably strong demand, as did firms in the defense space. A broader set of businesses also had upbeat reports. For example, several manufacturers noted a pickup in demand, and numerous banks shared that solid loan demand reached beyond the more predictable, booming pockets of the economy.

Forward-looking sentiment felt more guarded among firms that lacked direct exposure to data centers. Those firms paired reports of solid current demand with a strong dose of caution about future demand. Firms exposed to data centers still flagged a few concerns, such as capacity constraints and hyperdependence on a few clients, but they were largely optimistic about demand in the near term.

Business-to-consumer (B2C) firms were particularly cautious about future demand. They continued to flag that consumers were price sensitive and relied on creative choices to sustain spending. For example, consumers were eating out but splitting entrees; they were also buying groceries but opting for discounts over preferred brands. Some of those creative choices involved making ends meet in the present but taking on future risk, turning to "buy now, pay later," or skipping out on health insurance.

Labor: Did Firms Anticipate Ending the Year With Higher or Lower Headcount?

Hiring plans were highly correlated with demand certainty. The vast majority of firms shared they expected headcount to either stay flat or grow by year-end. Those with more confidence in the sustainability of their firms' demand were more likely to plan for headcount growth in the coming months. Some staffing firms shared clients were increasingly bulking up on contract work in hopes that 2027 budgets would allow them to hire those workers permanently.

AI largely continued to slow hiring as firms tested its potential, especially for white-collar positions. At the same time, several firms reported they hired workers with AI-specific skills to better leverage and deploy the technology. Many firms discussed that AI would enable them to grow faster, and some noted AI could help them cut headcount if demand were to contract.

Wage pressure resurfaced in select pockets. Overall, while wage normalization continued, there was an uptick in the number of firms that mentioned wage pressure. This was particularly true in the Carolinas, where there was also an increase in the number of firms that flagged labor availability and quality concerns. A few banks in the Carolinas confirmed renewed wage growth among lower-income clients, pointing specifically to the manufacturing and construction sectors. In Washington, D.C., Maryland, and West Virginia, a few examples of higher-than-normal merit increases arose too. A few firms explained they wanted to help employees keep up after this year's elevated inflation.

Pricing: How Much Cost Pressure Did Businesses Pass on to Customers?

Cost pressures felt more widespread than recent cycles. Firms mentioned a broad set of rising input costs: construction materials, fertilizer, chemicals, diesel, electricity, technology, software, transportation, AI tokens, health insurance and more.

Price growth continued to normalize but was not yet normal. B2C firms emphasized that despite high costs, they felt little ability to pass on costs to customers. Several firms that had previously opted for a "price up, volume down" strategy reported a renewed focus on supporting volume — they were discounting or increasing value to stimulate demand. Business-to-business (B2B) firms were still passing along cost increases but only some expected demand destruction. Productivity improvements and tariff refunds were helping to support margins for both groups of firms.

Pricing power had limits among firms providing data center inputs. Largely, firms reported intense demand for the land, material inputs, and labor required for the data center buildout. While this often translated into strong pricing power, some firms said they felt they could not take full advantage. They had to price competitively to secure the multiyear demand required to justify necessary expansions. Others noted that the need to preserve long-term customer relationships outweighed the short-term appeal of more rapid price growth.

Looking Forward: Where Are We Headed?

As we continue to engage with businesses across the Fifth District to track progress on our dual mandate, we'll ask: Do consumers continue to spend? Do price increases lead to demand pullback or no consequences? Does hiring pick up, or does caution continue to keep employers on hold? And do firms find ways to pass along cost pressures, or do they feel increasingly forced to absorb them? Does productivity help them do so?

Views expressed are those of the author(s) and do not necessarily reflect those of the Federal Reserve Bank of Richmond or the Federal Reserve System.