Diane Swonk

It is easier to think about how one might act at the Fed under such a scenario than actually live it. They will likely cut but it will is not as much of a slam dunk, given the risk of much higher inflation as it would otherwise be.

The probabilities of a September rate cut just soared, along with the risk of stagflation - a toxic mix of rising inflation and unemployment. That is what the Fed forecast in June and still had 7 who expected no cuts this year. The pressure on the Fed to cut in Sept is huge.

That is a tough decision, given the tariffs in the pipeline, which could double the effective tariff rate by year end.

Uncertainty regarding tariffs remains elevated given the new tariffs announced this week, which is further taxing the economy.

Bottom line

Today’s data affirms the dissents by Fed Governors Waller and Bowman at the July meeting. The challenge for the Fed is to cut once it is sure that the weakness in the labor market will make any bump in inflation due to tariffs short-lived.

The ranks of the unemployed swelled in July, along with those having to accept part over full time jobs. The stress measure of unemployment, which includes marginalized workers jumped to 7.9% in July from 7.7% in June. That is higher than 2019 norms & highest level since Feb.

The data is not apples to apples as the breakdown between foreign-born and native-born workers are not seasonally adjusted. Foreign-born workers have fallen by 1.5M since April, the largest losses since the onset of the pandemic in 2020.

Most federal workers are employed outside of the Beltway.

The unemployed rate was 4.2%, which underscore how little it takes to hold the unemployment rate steady. The civilian labor force contracted in July, while the participation rate fell for the third consecutive month.

Federal workers are down by 81K since the start of the year. Those losses largely reflect retirement amidst a hiring freeze. More to come on that front as severances lapse in the fall. @AtlantaFed had estimated that spillover effects to local ecosystems could hit 1.2M.

Some sectors are seeing wages approach or dip below levels of inflation again. That erodes purchasing power.

The Fed will be looking for consumers to push back against tariff increases to ease up on policy.

We still expect the first cut late this year in rates.

Bottom line, compensation held up but not evenly in the second quarter. Gain in wages offset slowdown in benefits - incentive pay played a key role.

Productivity growth was weak in the first quarter and could rebound in the second quarter due to swings in GDP.

the second quarter of 2023.

Largest losers were in accommodation and food services, which dipped to 2.9% in the second quarter from 3.9% in the first. That is is slowest pace since the first quarter of 2016. Leisure & hospitality feeling a squeeze. Vegas is feeling the pain.

Compensation surged at a 5% pace from a year ago in the second quarter, it hottest pace since the fourth quarter of 2022.

Finally, information jumped 3.5% from a year ago in the second quarter, well above the 1.9% pace of the first quarter and the hottest pace since…

…in the first quarter to a 3.8% increase in the second quarter. That is its hottest annual pace since the first quarter of 2024 and is occurring despite a contraction in construction activity.

In Finance, the big mover was real rate and rental and leasing.

Some of the biggest winners in the compensation race goods producing indices, which saw an acceleration outside of manufacturing. Construction is the primary driver, again an area heavily dependent on foreign-born labor. Compensation surged from a 2.9% increase in…

Public sector wages missed the initial upturn during the hirng frenzy and are still growing much faster than private sector wages. State and local governments have also been hiring up and the job opening data suggests that demand remained buoyant at the end of June.

..reflect a combination of strong demand due to aging demographics, the push to replace worker who quit during or after the pandemic and a heavy reliance on in foreign born skilled and less skilled labor.

Much of the shift from wages to benefits cooling was due to a rise in bonuses and commission. Finance stood out, buoyed by market volatility early in the quarter.

One outlier on the trajectory of compensation gains is healthcare and social assistance, which likely..

The employment cost index rose 0.9% in second quarter, matching the pace of the first quarter. That pushed overall compensation for civilian workers up 3.6% from a year ago, the same as the first quarter.

The composition of gains shifted. Wages rebounded but benefits slowed.

Current and proposed tariffs are much larger than anything we saw in 2018-19 when effect tariff rate popped above 3% for a bit before receding.

Hard place to be.

..tariff-effects. The Fed hopes that those effects will taper off on inflation. They also deal a blow to profit margins.

That could impact employment. The effective on employment outweighed the price effect, even though they were large, in 2018-19.

..leverage of bonded warehouses in Free Trade Zones.

The effective rate has been about 9-10% but is moving up and could double by year end given flurry of new tariffs levied.

Tariffs take 6-18 months to work their way through the economy. More to come.

..coffee and staples are all susceptible to tariffs. Diapers and baby formulas on that list as well as toys.

Worse yet, the effective tariff rate was held down in recent months by stockpiling, reshuffling supply chains, pauses on most prohibitive tariffs & ..

…onto consumers by companies.

Some are unavoidable, due to shear size of tariffs.

Still unclear how much will stick. There is a gap between what companies want and can do.

Brace for another move up in prices, especially at grocery store, as many packaged foods,

Core services inflation has cooled but remains well above the levels we saw in 2019. It is still at 3.2% on a Y/Y basis, despite further cooling in airfares. That is well above the 2% pace of 2019.

Powell cited Fed surveys that reveal a desire to pass tariff costs…

Overall 2.6%, up from upwardly revised 2.4% in May.

Core PCE up 2.8%, in June and May with upward revisions.

Big ticket durable goods - those most susceptible to tariffs rose at fastest Y/Y pace since December 2022.

ummer heatwave

Today’s revisions for PCE index changes the narrative on inflation a bit.

Upward revisions show more inflation in the second quarter and in June. The increase was driven by a jump in goods inflation.

Growth whipsawed by mother of all front running cycles. Underlying economy weak with inflation. Tough for Fed.

For the Fed, it will keep rates on hold. They will have the implied PCE data as well. That may not change the stance of Governors Waller and Bowman who could dissent but could harden the resolve of the rest of the participants to “wait and see” before signaling a cut in rates.

…liquidate those inventories prior to further increases in tariffs on August 1.

We also still have sector tariffs in the pipeline.

We expect the effective tariff rate to move from less that 3% at the start of the year to above 20% at end of year.

More tariffs are due out on August 1. The effective tariff rate was held down leveraging bonded warehouses in Free Trade Zones, which enabled firms to delay tariff payments until imports that they stockpiled were needed. There is likely a rush to…