Softer jobs and hotter inflation data shape upcoming policy response from the Federal Reserve
Every new round of jobs, inflation, and consumer sentiment data provides fresh clues about where the economy is headed and where policymakers will likely focus their attention. While the economy’s foundational strength has powered it through the turbulence around tariffs, taxes, and the federal debt to date, signs pointing to pressure from a softer job market—albeit with prices rising above inflation targets—cement a quarter-point (0.25%) rate cut by the Federal Reserve (Fed) at the September 17th meeting.
Recent jobs reports show a decidedly weak trend in job growth; however, there appears to be more nuance in the details. For instance, the underlying segment-level losses were more muted, and the unemployment rate is at 4.3%, just a tick higher than a year ago. Also, the recent 27,000 bump in jobless claims was largely localized due to floods in central Texas. Modestly softer jobs data is not surprising given that business decisionmakers have been in the “no hire/no fire” mode as they deal with the uncertainty around tariffs and their effect on the overall economy, complicating personnel decisions. Many businesses seem to view the tariff uncertainty as temporary as evidenced by the modest reacceleration in job growth – averaging about 50,000 per month in July and August after practically no growth during May and June. Our hope is that the boost in the more recent July/August periods is in part a result of the passage of the One Big Beautiful Bill Act (OBBBA) in early July and additional clarity on tariffs, including deals with the European Union, Japan, and South Korea, and extensions for China—all removing some policy uncertainty.
With weaker labor data comes indications that inflation is running hotter in August – up from 2.7% to 2.9% annually – as the effect of tariffs creep into prices. Food and energy ticked up 0.5% and 0.7%, respectively, in August. While most of the evidence of tariffs appears in manufactured goods with motor vehicle parts and equipment up 3.4% annually, tires up 3.9%, and home furnishings up 2.8%, some imported food can be subject to tariffs as well. Tomato prices are up 5.1% under pressure from a 17.1% tariff on fresh tomatoes from Mexico—60% of the total U.S. supply. Furthermore, inflation within consumer services is running hotter than overall inflation. Yet, there are positive signs looking forward as wholesale prices ebbed in August, with the Producer Price Index (PPI) cooling to 2.6% from 3.3% in July. Additionally, nonfarm productivity reaccelerated after two softer quarters while unit labor costs rose 1%, down sharply from 6.9% in 4Q24.
The strength of the U.S. consumer—a pillar of the economy over the past few years—is a key indicator of where the economy is heading. After July gains, consumer sentiment reversed direction in August and September. One-year inflation expectations are back to 4.8%, though remain elevated relative to longer-term averages. How the Fed views the latest indicators is unclear, particularly considering the many tariff-related distortions in economic data. While the weaker jobs trend is spurring talk of larger or more Fed rate cuts this year, we still expect the Fed to move cautiously to ensure that the recent weakness is temporary and inflationary pressures aren’t mounting. If both the labor market weakness and inflation prove temporary, then we could see the Fed continuing to lower rates, perhaps even a quarter-point rate cut at each of the remaining three meetings this year. Or more weakness could spell a half-point cut (0.50%) at one of those meetings. While markets may be jumping to the conclusion that the Fed will lean toward significant easing, there’s a lot of data between now and those meetings, including several more jobs reports and inflation readings, which will be critical in determining the speed and size of potential rate cuts.
Bottom line:
The U.S. economy continues to muddle-through. We’re hopeful that the modest reacceleration in job growth during the past two months will persist, supported by certainty in tax policy and further clarity on the tariffs. But we expect that the Fed will likely proceed cautiously until there’s more evidence, which means a quarter-point rate cut at the September 17th meeting.
