The Next Annual Revision

The monthly employment report sources data from two surveys: the Current Population Survey (the CPS or “household survey”) and the Current Employment Statistics (the CES or “establishment survey”). And every year, historical data from the CES undergo a substantial annual revision that incorporates more complete data from a 3rd, more comprehensive data source: the Quarterly Census of Employment & Wages (QCEW).1 The QCEW is published with a substantial lag (about five months after the CES) and is much noisier than the CES, so the QCEW-derived “benchmark” level of nonfarm employment is applied to CES data only once a year.2 For instance, in January of 2026, a benchmark revision using primarily QCEW data was applied to the level of March 2025 nonfarm payroll employment.34

Over the last few decades, benchmark revisions have been both positive and negative. But the past three rounds have all been negative: March 2023 (-266K; -0.2% of nonfarm payroll employment), March 2024 (-589K; -0.4% of nonfarm payroll employment), and most dramatically, March 2025 (-898K; -0.6% of nonfarm payroll employment). A lot of folks, myself and the Fed included, assumed we were headed for another negative benchmark revision early next year when the data is revised from (to the level of employment as of March 2026).

But that assumption seems increasingly incorrect. The QCEW is released quarterly, and last week we received the Q4 2025 data. That means we now have three-quarters of the data that will be incorporated into the eventual benchmark revision. And that “three-quarters complete” QCEW data indicates that, between December 2024 and December 2025, employment grew substantially faster than the payrolls data currently indicate (by about 230K). At the same point in 2023, 2024, and 2025, the QCEW was showing slower growth than NFP by 694K, 735K, and 907K, respectively. In each of those years, we had negative revisions (though not quite as negative as QCEW implied).

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What comes next for the Fed will likely be a fractious period of (polite) public disagreements, policy dissents, and questions on the institution’s ability to remain independent while staying on top of an increasing number of inflationary shocks. That’s not a statement meant to be critical of the FOMC. It’s an assessment of the structure of our economy, the nature of the current political environment, the condition of economic data and models in the post-pandemic world, and the personality mix and objectives of individual FOMC members.

To be fair, this isn’t all about Kevin Warsh; these seeds were sown long before Trump floated him as a potential Chair. But Warsh enters the Fed at a time when consensus is breaking down — see the recent spate of dissents — with questions about the institution’s ability to maintain its independence, and his willingness to defend it. That backdrop will make it even harder for him to deliver on his policy goals, many of which run counter to the current stance and recent decisions of the rest of the FOMC. His ability to navigate this new, only partially understood, economy while guarding Fed independence will define the early years of his Chairmanship. And unfortunately for Mr. Warsh, he may not have much control over his own fate, or ours.

A New Fed for a New Economy

Long-time readers will not be surprised by our belief that the economy is in a new, more volatile era. In fact, Access/Macro was started in part because of a speech by central bank legend Mark Carney — he has the distinction of being the only person to have served as the Governor (head) of two separate central banks, Canada and the Bank of England; he’s now the Prime Minister of Canada. In that 2022 speech, Carney laid out a prediction:

The economic environment is now very different from that which reigned since the global financial crisis. The long era of low inflation, suppressed volatility, and easy financial conditions is ending. It is being replaced by more challenging macro dynamics in which supply shocks are as important as demand shocks, increasing inflation, volatility, interest rates and risk premia. The reaction functions of central banks must adjust accordingly. Climate policy is becoming the third pillar of macro-economic policy.

Carney was talking specifically about climate risks and shocks, but his view that we’re in a more volatile period extends to all parts of the economy. You can see it in financial markets. Figure 1 shows just how much volatility has entered equity markets in the current expansion. The chart tracks the monthly average of the VIX index, which measures the daily volatility in the S&P 500. Each bar represents the percentage of months in that expansion that qualify as low-, medium-, or high-volatility, based on a classification from S&P. For example, 32% of the months during the 1990’s expansion were classified as low volatility.

Take a look at the current expansion. The number of high volatility months has risen from 8% during the long 2010s expansion to 18% today. But the real movement has been in the number of medium-volatility months. During the 2000s and 2010s expansions, the shares were 41% and 49%, respectively. That percentage has skyrocketed lately, reaching 68% in the current expansion. We’re in a new era, and markets are pricing for it

So, what’s driving the volatility? A confluence of structural forces that have been accruing for decades. Figure 2 highlights a few of the most pressing, but it is by no means a complete list. These forces are rewiring the economic connections that have defined our economy for the last forty years. And, it is clear they will be with us for at least another decade, if not more.

What is also clear is that these factors are well outside both the purview and the control of central banks. They are broad global forces with complicated intersections. However, they share a few commonalities. First, nearly every one of them — AI is potentially the exception — is likely to disrupt markets and supply chains, thereby fanning the flames of inflation. Second, these tectonic shifts will lead to greater swings in economic cycles — faster expansions, deeper and/or longer recessions, and potentially slower recoveries. That shifting landscape poses a significant risk to central bank credibility if the public loses faith in those institutions that fail to manage the economy with the steady hand we’ve come to expect. And this is happening at a time when traditional models and data are showing wear and tear, complicating policymakers’ ability to see the runway.

Central bankers are generally a cautious group by nature. They understand that monetary policy has always been as much art as science, and that changes to interest rates usually take years to filter through the economy; Milton Friedman famously described it as “long and variable lags.” But incomplete models and degraded data argue for even more caution and patience than usual. Why act swiftly if you’re more unsure of the surroundings — better to wait and let conditions reveal themselves. But that is in direct opposition to what the new world requires. We’re dealing with more shocks and less predictability. More opportunities to misread the tea leaves and less forgiving terrain. Under those conditions, central banks must be humble in their assessments, short in their memory, and nimble in their actions. They must stand ready to act quickly and decisively to quell shocks before they become malignant. And they must be ready to reverse course if the conditions require it or if they overcalculate. That tension between needing to remain patient and humble to first do no harm runs right into the need to be agile and, in some ways, reactionary to quell persistent and unpredictable shocks. That paradoxical tug-of-war is going to define the next decade of monetary policy.

A 2026 Fed led by someone other than Kevin Warsh would be facing the same reality. That FOMC would be exposed to the same political pressure, the same supply shortages, and the same volatile geopolitical and environmental landscape. But that alternative Committee might also have an incoming Chair who isn’t at odds with existing monetary policy and regulations. Someone who hasn’t been championing policies that would force a 180-degree reversal of recent FOMC decisions, even if they may be needed. Whether one agrees with Warsh’s assessment or not, his objectives are plainly stated and clear. The question is, can he pull it off? Early signs suggest probably not. He’s going to run into a wall of resistance inside the Committee if he comes out swinging, especially with inflation heading in the wrong direction. And if he doesn’t, he may run into the speeding train that is the President’s Truth Social account. Either way, it’s going to be an interesting second half of the year. And it’s going to remake the way the Fed communicates with the public.

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1. “Low hire, low fire”: Employers are restraining headcount growth by turning down the hiring dial rather than cranking up the layoff dial.

2. “No country for young people”: The labor market has deteriorated much more for young people (of all education levels; not just college grads) than for prime working-age Americans.

Gross hiring, the number of folks starting new jobs, was red-hot in 2021 and into the beginning of 2022. But early that year, it began a large decline. By late 2023, hiring had not just returned to normal but crossed over into “unusually low”. Employers, who faced slowing demand growth after the initial burst of post-pandemic recovery, were trying to right-size their workforce through weak hiring. Hiring rates are currently comparable to early 2010s levels, when unemployment was far higher than it is today.

However, employers were reluctant to accelerate this right-sizing process through a wave of layoffs. Layoffs did increase modestly from 2021-22 levels, but remain very low by historic levels (despite doom-filled headlines triggered by tech sector layoff announcements). The reason for this is not entirely clear. Perhaps firms are still traumatized by the rapid post-pandemic recovery, when prior layoffs suddenly left them short-staffed. It’s also possible that a combination of uncertainty and a relatively stable economy (no recession) has convinced them that they can take their time via gradual attrition.

But regardless, this “low hire, low fire” environment has a powerful distributional effect on America’s workforce. Older workers, who are generally likely to already have a job, remain at low risk of layoff. The weak hiring environment does hurt them a little - the pace of pay increases has slowed due to fewer outside opportunities, and people who hate their jobs reluctantly “hug” them because there’s so little out there. But people who don’t have jobs bear the brunt of weak hiring, and because layoffs are so low, the hiring freeze overwhelmingly impacts the young. The unemployment rate for people of prime working age has increased slightly over the past 3 years, but not nearly as much as for people in their early 20s and late teens.1

Both of these features regularly land in the business section of the newspaper, if not on the front page.2 But that discussion is focused primarily on the short term, despite being a phenomenon with possible long-term repercussions. Those repercussions on the business side are the subject of this month’s post.

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But what if the administration knows that it isn’t possible? What if they know they’d be setting their guy up for failure if he starts in May? This may not be a masterstroke of Sun Tzu-level strategy, but what we see in the headlines and quotes may also be misleading. That’s because it’s undeniably better to have a political punching bag in an election year than a bruised Fed Chair who can’t deliver.

Senate Standoff Ad Infinitum

The good news for the Trump Administration is that Kevin Warsh has a Nomination Hearing scheduled before the Senate Banking Committee on April 21st at 10 am Eastern. As a respected former Fed Governor during the Global Financial Crisis and its aftermath, he is likely to meet little resistance from Republicans and only moderate resistance from Democrats. In other words, it’s very likely a done deal that he is the next Chair of the Fed, whenever that hearing actually takes place.

The problem is that Republican Senator Thom Tillis of North Carolina is still vowing to block the nomination until the United States Attorney for the District of Columbia, Jeanine Pirro, relents on the investigation into Jerome Powell and the construction of the Fed’s updated headquarters. In fact, a Nomination Hearing on the same topic, set for tomorrow, was canceled last week, presumably for the same reason. And Tillis isn’t the only Republican balking. Senate Majority Leader John Thune of South Dakota, also a Republican, just hours ago publicly stated that he thinks “it’s in everybody’s best interest to wrap up the investigation. I’ve said that before, it would be better if it winds down.” It’s not an exaggeration to say that this is the most resistance that Republicans have shown to any of Trump’s initiatives in his second term. Tillis likes to spar with Trump, and he’s not running for re-election. He’s a senator until January 3rd, 2027. He has nothing to lose and a lot of time not to lose it.

Ok. So, if Tillis can hold up the nomination process, and all he wants is for Pirro to end her likely politically motivated investigation, is the Administration likely to acquiesce and call off the dogs? If you answered yes, you’re not living in 2026, or you don’t know Trump. I point you to Exhibit A — the unannounced drop in by Pirro’s office to the Fed’s construction site. Exhibit B is the President’s response on Fox News this morning when asked about the probe, “If ​he's not leaving on time - I've held back firing him, I've wanted to fire him, but I hate to be controversial, you know. I want to be uncontroversial, but he will ​be fired.” That doesn’t sound like a President ready to concede that he can’t win the fight.

What Star Trek Can Teach Us About 2026 Monetary Policy

There is no question that Trump hates Powell. He feels duped into nominating a Fed Chair who wants to assert the institution’s independence, and the President is rightfully concerned about the economy. He wants a Fed Chair who is eager to lower rates by a lot, quickly. Lazy money would be on a TACO move at the last minute to make sure Warsh is in seat by May 16th. But, look a little closer, and you’ll see that perhaps the motivation isn’t as strong as it would appear.

Let’s assume that Warsh is, in fact, as zealous as Trump wants him to be about cutting rates. In that world, he walks into the FOMC in mid-May, calls a lunch meeting with his fellow Governors to twist some arms, takes a train up to NYC to shout at John Williams, the New York Fed President, and spends his train ride back calling the other 11 Regional Fed Presidents to convince them that this is not the inflation they are looking for. Even if the FOMC is riddled with groupthink, which it isn’t, that’s a lot of people who are increasingly nervous about inflation, who need to do an about-face. Don’t confuse the Fed’s culture of consensus with one of obedience, especially an FOMC that feels like it’s been under attack for over a year. Not happening.

What about data? Can he effectively use that to argue for a rate cut right now? Two letters, one syllable: no.

Each voting member of the FOMC is independent. Yes, the Board can and does make requests to regional banks behind the scenes, but it’s never about monetary policy decisions. That’s an open debate and the last two years of regular dissents and public commentary should make that obvious.

So, if he can’t use the data to convince his colleagues, and he can’t come in guns blazing, can he really lower rates in the near-term? Same two-letter word: no. And it’s very likely that many in the Administration know this. Just yesterday, Treasury Secretary Bessent said that while he thinks they should eventually lower rates, he understands “if they want to wait for some clarity,…”

Everyone knows more inflation is coming. The Iran War guarantees that. And as we’ve discussed in previous posts, the economy had an inflation problem before the Iran War kicked off. Warsh’s arrival now would almost certainly put him in a no-win situation. Stuck between a hardened FOMC worried about inflation and a President who can’t help but attack Fed officials for not lowering rates. A true central banker, Kobayashi Maru. And Warsh isn’t Captain Kirk. He can’t just rewrite the program.

Strawman Punching Bag in an Election Year

We’re not the first to say this, but keeping Warsh away from the Fed at this moment has benefits for both Warsh and the President. For Warsh, he doesn’t start his second tour at the Fed off as the most weakened Chair in modern history. For the administration, they don’t have to throw the preferred Republican choice for Fed Chair into the political woodchipper on day one, and it affords the President something he loves: a punching bag, in an election year.

Let’s say that the economy starts to falter going into the midterms. The president can conveniently blame Powell and the Fed for not lowering rates. We’re not saying that would work. But that has a better chance than installing your own guy, only to find yourself blaming him five and a half months later if the economy turns. Again, we’re not arguing that Trump is playing 4D chess; it’s obvious he lacks self-control and that many of his policies are, at best, contradictory. However, he and some in his administration likely see the writing on the wall and recognize that patience may be beneficial. And in the meantime, he can keep hounding and threatening Powell with little repercussion, and the Justice Department can continue to make surprise visits to the construction site, knowing they’ll be repeatedly turned away.

This is the de facto short-term equilibrium. Expect it to persist past Powell’s “last day” as Chair on May 15th, with a chance for it to continue right through the summer and into the midterms. There’s little to lose and much to gain.

This indicator, produced by an entirely different survey from nonfarm payroll employment, undergoes only minimal revisions over time, even if responses rates have been dropping. It’s relatively unaffected by the pace of population growth. And historically, it tends to be closely related to the state of the economy – moving slowly in normal times, surging very quickly during recessions.

I got some pushback from our readers, so I thought I’d use this month’s Labor Market Watch to elaborate on why I like the unemployment rate, imperfections and all.

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Facts and Uncomfortable Truths

It happened again today. You probably missed it between the headlines that we may or may not have a ceasefire in the Middle East. Consider this your update. This morning’s Personal Income and Outlays release was not great. In fact, it was bad. We’ll get to the consumer side in a separate post. This one is about the inflation problem no one wants to talk about. But first, here are some facts.

• The data we just received was for February 2026. We’ll get the March data drop on 4/30. Stay tuned.

• The yearly change in inflation, also called the 12-month change, dropped from 3.05% to 2.97%. HOORAY! That’s exactly where it was last February at 2.97%. HOORAY AGAIN! And it’s lower than the 3.06% rate in February of 2024. HIP, HIP HOORAY! Mission. Accomplished.

• The Fed’s target is 2.0%. Ummmmmmm…

• February was always destined to decline because of a statistical quirk called base effects, in which last year’s reference point influences the percent change this year. And those positive base effects are in the rearview for 2026. Is it me, or is it getting hot in here?

• As the figure below shows, the monthly pace of core inflation (green bars) is still very far above the monthly pace that will sustainably bring that yearly pace down to the Fed’s target of 2.0% (black line, aka the speed limit). Look at that jump. We’re cooked.

That was the rollercoaster of emotions I went on this morning as I sifted through the data and read the release. It’s 2026. I should be used to that kind of whiplash, but somehow it still stings.

At this moment, you might feel the urge to find comfort and shelter in that decline to 2.97%. Let me provide some perspective for you. Back in Access/Macro’s December forecast, we expected a 0.35 percentage point (ppt) drop in the yearly change in February. The actual change was 0.08ppt. That’s a massive difference between the forecast and the outcome. Is that because the forecast was bad? Perhaps. But I refer you to the chart above, which shows the recent surge in the green bars.

Here’s some more level setting. The chart below has three green bars. Each one is the annualized change in the core PCE index from November to February for the given year. Annualized means that we took the change from November to February and did some algebra to show the pace of inflation over 12 months if it had grown by that Nov-Feb change for the whole year. That last bar, the one that says 2026 below it. That’s a scary number. It tells us that if things don’t change, inflation will hit 4.5% by this time next year. It would be 2021 all over again.

The Fed Isn’t Talking Enough About Context — Expect to Hear More Soon

The cold, hard truth is that the 12-month change in core PCE inflation was last below 2.0% in February of 2021. That’s sixty months of inflation above the Fed’s target. Six. Zero. The last time that happened was in early to mid-1990’s, which was the tail end of the late 1980’s inflation shock. The FOMC didn’t have an explicit inflation target back then, but that episode was one of the reasons central banks around the world started discussing inflation targeting — the practice of targeting a specific inflation rate rather than just throwing darts at a board to hit “stable prices”.

That’s the point. Context matters. And the context here is that inflation has been above target for forever. That fact is making policymakers uncomfortable; the chorus of hawks has grown louder since last October’s FOMC meeting, when labor market concerns waned. Powell mentioned the importance of context at the March press conference:

“And I think now it’s also dependent now on what you mentioned, which is that broader context of five years now of inflation above target. We have to keep all of those things in mind, and the question of “looking through,” when it does arise, will be one to approach not lightly but, you know, in the context that you mentioned.”

The beauty of Fed decisions has been in the eye of the analyst over the last few years. Some would argue that the Fed was slow to react to inflationary pressures and remains behind the curve. Others would argue that they’ve shown remarkable restraint in the face of simmering, not boiling, inflationary pressures — they were close to landing the plane gently on the runway.

None of that matters now. The ground is shifting beneath our feet. We’re inching towards a significant market repricing, because of context. Because five years in is different than a surprising post-pandemic surge. Because it’s increasingly obvious that we live in a world of regular supply shocks now. Policymakers have to take all of that as given, as context.

Expect them to start talking a lot more about it as they weigh raising rates later this year. The only thing that would stop them is better inflation data. But, with the full effects of the Iran War still in the pipeline, we very well may look back on this February Personal Income and Outlays release as the calm before the storm.

Markets need to wake up. It’s about to get worse, for a while, before it gets better.

Tim Mahedy is CEO and Chief Economist at Access/Macro, an independent macroeconomic research firm.

The AI headlines continue to push a false dichotomy. According to the people writing the code, it will either force us to toil away for a less-than-benevolent Skynet overlord, or allow us to relax on a beach while soaking in the rays, and our universal basic income.

Overhyping AI is great for stock valuations and FOMO-driven marketing pushes, but it completely obscures the most likely AI outcome: productivity gains for skilled employees, but a persistently sluggish labor market for younger workers.

It’s 2026, so extreme takes are en vogue. But the truth is that tech can be transformational and still not upend society. Living in the infinite set of over-hyped future worlds conceals not only what is likely to happen, but also what businesses should do about it.

The AI Apocalypse Isn’t Coming — But Younger Workers Will Struggle

The early months of 2026 offered a brief reprieve from all the labor market pessimism. January’s employment data showed the economy adding over 100,000 jobs. But the celebration was short-lived. The February data reversed course sharply, and the scary headlines followed: recession fears, AI-displacement horror stories, and just general doom and gloom. The rollercoaster ride continued in the March data, with the preliminary release indicating that the labor market rebounded, adding over 175k jobs at the end of the first quarter.

We’ll forgive you for getting motion sickness. For those of you keeping track, the net balance for employment in Q1 was an average monthly pace of 68k. That is the highest three-month average since April 2025. So clearly good news, right? As one of my mentors used to say, “weeeeeeeellllllll.”

Don’t forget that we’ve had persistent downward revisions to the employment data over the last few years, which means that the current three-month average is likely to fall, maybe by a lot, later this year. Economists love to talk with both hands. Bear with me. So which is it? Is the labor market strong or weak? That’s a challenging question to answer from official government statistics. We need more information to triangulate.

Homebase’s February Main Street Health Report captured something the headline numbers missed: workforce participation held flat in the early part of the year, but hours worked edged up, “signaling stabilization, not expansion.” That distinction matters. A labor market where people are working more hours but fewer new workers are being absorbed looks different from one in collapse. But it also looks different from a healthy one. The latest March report showed even more strength.

The trillion-dollar question is: how much of these changes can we blame on AI? Sure, the world is in a period of intense geopolitical disruption, demographic drag from aging Baby Boomers, and just general policy uncertainty, really on almost every front. Those are all scary in their own right, and even more terrifying when combined. But we’ve all seen Terminator, right? It’s the overlord you have to fear. Not all that other stuff. Or so we’ve been led to believe.

To understand where we’re going, look back at where we’ve been. This isn’t the first time we’ve had panic around technological innovation. In a seminal 2015 paper on automation and employment, MIT economist David Autor documented the consistent tendency of each new wave of technology to generate catastrophic predictions that fail to materialize at scale. He pointed to a 1961 Time magazine headline — “Business: The Automation Jobless” — as an early example. The piece quoted former Pennsylvania Congressman Elmer J. Holland: “One of the greatest problems with automation is not the worker who is fired, but the worker who is not hired.” Sound familiar?

Research actually agrees with Holland, just not at the aggregate, economy-wide level. Autor’s research notes that new technology has never led to a permanent, economy-wide loss in jobs. But it can reshape whole industries. Just look at the manufacturing sector over the last few decades.

Manufacturing employment is down just over 27% from March 2000 to March 2026 — a decline driven by a combination of trade exposure and automation. That kind of industry-level displacement is real and obviously persistent. And we could be entering another cycle. AI almost certainly will hollow out certain white-collar employment. It’s able to do entry-level tasks with ease, and increasingly more accuracy, at a fraction of a fraction of the cost of a full-time newly minted graduate. There’s little chance that future generations of accountants, lawyers, and economists will not be impacted.

We use AI extensively at Access/Macro, for its highest use function - coding. So, what I’m about to say is based not just on trends and historical analysis. It’s coming from the heart of someone who has spent many long days learning how to use it. Despite all its value, AI remains error-prone, constantly disrupted with quality issues, sycophantic, even when you tell it not to be, and lazy, by design. Getting a good answer out of it is an art, not a science. To really maximize its potential, you have to know how to do the work without AI.

Here is where the futurists will jump in, “but, but, but it’s going to get better. And data. And more data. And models. And you don’t know what it can do. And limitless potential. AND LOUD NOISES!!!!” You can almost hear the desperation that every proclamation will drive stock valuations even higher.

Here’s the deal. We’ve had baby AI in the sciences for decades. Yes, the current stuff is souped up and uber-powerful. Yes, it has ingested more data than anything we could have realistically imagined even a decade ago. But, and here’s the thing that really grates the futurists: you can’t ingest enough data or build a model good enough to reliably predict macro events. This isn’t Minority Report. Don’t at me with “this time is different.” Or do, and we’ll have a debate. That’s what comment sections are for. In the meantime, let’s look at what history tells us is most likely to happen and thus, what businesses, banks, and everyone need to do. I’ll say it one more time: To really maximize AI’s potential, you have to know how to do the work without AI.

And there lies the conundrum for younger workers, and ultimately, future talent pipelines. In a world where AI adoption continues to spread and the tech continues to improve, how do young workers stay relevant and in demand? Before we answer that question, let’s take a detour. We’ve talked a lot about the impact on the labor market and what the tech can do. But we haven’t talked about what policymakers can do to help smooth the transition. The answer may be surprising and disheartening.

The Fed’s Get-Out-of-Jail-Free Card They Can’t Control

AI’s implications extend well beyond the labor market. It has the potential to alter the economy’s growth path through higher productivity. A sustained acceleration in productivity would also improve the trajectory of inflation (less) and redefine what “neutral” monetary policy (not damaging interest rate level) actually means. That sounds great for today’s Fed, and all of us! So how does it work?

The mechanism is straightforward. Faster productivity growth raises the economy’s speed limit; we could build more things and provide more services with the same number of workers. More growth with little or no additional labor costs would be disinflationary. Less inflation would allow policymakers to decouple the narrative around higher rates from persistent inflation, focusing on the strength of the economy, not the risks to it. For a Fed currently navigating over five years of uncomfortably high price pressures alongside a softening labor market, that narrative shift would be a welcome reprieve. It would also lead to an economy unburdened by the demand destruction of higher rates, and unshackled by the costs of stubbornly high inflation. Everybody wins. But is this world achievable? Yes, and there are subtle signs that the transformation may already be underway.

The Laubach-Williams model, created by NY Fed President John Williams and his coauthor Thomas Laubach, is the standard-bearer for estimating the real equilibrium interest rate — the goldilocks inflation-adjusted rate that neither fosters inflationary pressure nor restricts economic growth. Their framework uses advanced filtering techniques to estimate how that rate evolves over time. A stronger potential growth rate is a key driver of a higher neutral rate. That is exactly the world described above. As the figure below shows, the LW model is signaling stronger economic fundamentals and thus, a higher stopping point for the federal funds rate. The lines below show the implied equilibrium nominal interest rate (the model real rate + market inflation expectations), also known as “where the Fed should stop”, in two different time periods. The 2024:Q4 vintage (black line) is below the most recent 2025:Q4 vintage (green line). That means that the latest estimate of the Fed’s stopping point is higher than it was a year ago. But not only that, the bars below the lines — the difference between the two model runs — has been widening for some time. More could be coming with an AI-productivity boom.

Side note: the most recent vintage of that model puts the implied nominal equilibrium rate at 3.75%, placing it at the top of the current federal funds rate target range, which is one reason the Fed is on pause; the other is the persistence of and likely incoming shock to inflation.

But none of that is something the Fed engineered or can influence in the years ahead. What AI can do and how far it can spread are beyond the Fed’s mandate, and more importantly, its capacity. They can’t even do much to offset the “distributional effects” like who wins and loses, or cushion the blow to those who will be negatively impacted, other than running the economy hot, risking more inflation. They’re bystanders in all of this. That might be unsettling to read. It is when I think about it. But it doesn’t mean there’s nothing we can do. In fact, the true power lies with everyday businesses and banks to act in their own self-interest and preserve their talent pipelines. This is one of those moments where what’s good for business is good for society. But it’s going to take money and patience. Two things that are in short supply these days. For those able to stay the course, the potential benefits could be enough to make Scrooge McDuck blush.

Investments in Humans is the Future

AI is democratizing all kinds of work, from database construction and management to accounting to consulting. In the future, the competitive advantage won’t be whether you have AI — everyone will have access to it. The advantage will be whether your company has better harnessed AI to the specific contours of your business, multiplying the power of automation and your workforce. To do that, humans will need to know how to build, manage, and grow those systems to align with company-specific strategies. That will require a workforce trained not only to use AI but, more importantly, to get the job done without it. That’s going to require investment and patience.

But it’s been done before, and with great effect.

AT&T saw the writing on the wall in 2012 and 2013. With the telecommunications industry facing rapid change, the company decided to invest in its current workforce rather than spending to hire people with the right skills on paper. The executives were happy with the results. Bill Blase, AT&T’s Senior EVP of Human Resources at the time, noted the importance of an engaged workforce that is constantly learning to boost customer satisfaction and profits. And CEO Randall Stephenson said that “the difference between growth and obsolescence” will go to those who can “transition their talent at scale as technology changes.” The same will be true over the next decade. The companies that meet the AI revolution by investing in their workforce will be the ones that reap the greatest rewards.

Don’t allow today’s world of immediate gratification, short-term policy plans, the demand for yield, and overpromises about AI’s capabilities to cloud your long-term strategy. Stick to what we know: we’ve seen this kind of rhetoric before during periods of technological innovation, don’t buy into the hype or sell the fear; AI is powerful but ultimately needs continuous skilled human intervention; and the world isn’t ready for either of those. That’s not a cautionary statement. It’s a statement about opportunity.

Tim Mahedy is CEO and Chief Economist at Access/Macro, an independent macroeconomic research firm.

Read the published version in Barron’s

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The productivity boom that leads to a weak and concentrated economy. Citrini Research and Alap Shah published a provocative treatise/scenario on the tail risk from an explosion in AI productivity that leads to immense employment and wage destruction for white-collar work, and a historic slowdown in consumer spending that never truly recovers because, well, nobody has a job except the owners of capital. It’s a truly dystopian future, and as my colleague said, a liquidity trap since monetary policy can’t do anything to stop it. To be fair, the authors note that it’s just a tail-risk scenario they believe hasn’t received enough consideration. But it sent markets spiraling and made headlines today, so we decided to weigh in.

Citrini asks us to imagine that the year is 2028 and we’re looking back at how we arrived in a world dominated by machines and uber-capitalists, where the once “scarce input” of human intelligence has been replaced by an abundance of 24/7 AI data crunching and coordination that has led to massive layoffs for the upper income quintiles who “drive 65% of discretionary spending”. Without that spending, the economy hits a wall. Those who own the capital have buckets of money. More than they can ever conceivably use to buy their fourth yacht. And the rest of us, well, we’re sucking dirty water through a straw. Dark days indeed.

But how likely is this world to unfold? Is this the worst outcome to expect from years of runaway AI investment? And, even if it is, would it happen before the next presidential election? That’s a lot to unpack. If you’ve got better things to do, I’ll summarize by saying: it’s a cool piece that goes astray because the timeline is infeasible, and the assumptions needed are too improbable and unlikely to perfectly align in a way that is needed to bring about the apocalypse.

The assumptions don’t hold. In the abstract, this all might seem possible. If you’re concerned about AI, it might even seem likely. The growth in AI capabilities over the last three years is truly remarkable. And the investment in new models and data center capacity is staggering. But a liquidity trap where the Fed becomes impotent to battle a structurally weak economy with massive white-collar layoffs leading to massively contracting household consumption rests on a few impractical assumptions.

1. The capability curve doesn’t bend. Technological advancements have traditionally followed an S-curve: they start slowly, then rapidly accelerate as growth and adoption explode, and then level off as it becomes harder to advance, and the technology reaches performance limits. AI is no different (check out bullet 10 here). And say what you want about your new favorite model, but the gap between a trained expert and AI is still wide - don’t ever let it do your financial modeling without a watchful human eye and strict review.

2. AI reaches quality parity with senior, skilled workers. The dystopian AI-liquidity trap outlined in the Citrini piece requires AI to make leaps and bounds, quickly, to close the gap with skilled humans across so many industries that it shows up in the national data. That seems more than a few years away, and questionable if we ever get there. I don’t have data to support his claim, but as a regular advanced AI user, I can confidently say that the technology is both incredibly powerful and incredibly wrong much of the time, even with good prompting. Recently, and by that, I mean last week, I asked a new AI model to give me an answer to two questions. The first was on retirement accounting for small businesses. The second was on contracts. In both cases, I ended up turning to a human expert to fact-check the AI assessment. And in both cases, the AI model was wildly wrong.

3. Deployment is fast enough to matter by 2028. We’re humans, which means we get over our skis a lot. The AI boom is no different. The current pace of AI-related construction does not match our existing infrastructure. In other words, we don’t have enough power generation or connection across our power grid to meet what’s coming. Yes, tech companies are trying to match with on-site power generation, but it won’t be nearly enough to meet the basic needs of any of these facilities, so they’ll still be taking power from the grid. That’s going to be costly and politically explosive as rates rise quickly in certain parts of the country. That makes 2028 impossible. And that matters because the slower the pace of AI change, the better the human response will be.

4. Displaced workers can’t redeploy. As economists and extensive users of AI, we’ve long felt that the greatest threat from AI will be to younger workers who don’t remember how to do things the old way. The Citrini piece agrees but doesn’t address the very likely scenario in which businesses recognize AI’s limitations (more on this below) while failing to address the obvious talent pipeline issue by investing in their younger workforce through training. This isn’t just a pie-in-the-sky hopeful scenario; we hear from businesses all the time that they see the risks AI poses to their future workforce and are already planning on how to ensure that the next generation is ready, willing, and able.

5. The policy response fails completely. The idea that our policy institutions completely fail us may seem plausible in 2026. We won’t argue that. However, under this aggressive timeline, where things really start to degrade over the next few years, we’ll be entering a presidential election cycle, and it’s hard to imagine that massive across-the-board layoffs of large swaths of white-collar America wouldn’t be the centerpiece of every presidential platform on the menu.

The capacity limits of energy. There is little question that running AI models at scale is a national energy suck. The question is: can demand for energy be met by supply and/or by energy-efficiency improvements? The latter is happening, but as Anthropic recently found out, compute costs can skyrocket when users use more advanced models with longer context. And officials in major energy markets are already calling out the surge in demand and the lack of infrastructure as significant hurdles. We didn’t build the smart grid, and now we’re building data centers in every pocket of cheap power in America. At some point, it comes due, and even if there is technically enough power, getting that power across independent system operators (ISOs) that manage power for a region is a complicated issue, both politically and economically. In short, there is a power limitation on AI that no one has yet solved.

Technology has always been a job destroyer and creator. Lots of ink has already been spilled on how previous technological advancements both destroyed jobs and created them. I won’t rehash things here, but AI will need to buck all of modern human history if it is to be the apocalyptic job crusher that the Citrini piece lays out in their tail-risk scenario. And so far, there are signs that pandemic over-hiring has more to do with the recent weak job gains than AI. That’s not to downplay or dismiss those who have and will lose their jobs. It’s merely a statement of fact that technology often creates jobs while destroying others. There is no compelling evidence that AI is any different.

Don’t forget to quality adjust. The main argument in the Citirini piece, also made by others, is that AI unit labor costs are so drastically below those of a human worker that, even with a sharp rise in computing and energy costs, AI will remain cheaper than a human. But you need to quality adjust. As discussed above, there is still a vast gulf between a trained expert and AI. Even if AI were able to produce 75% of what a skilled human in noncoding tasks can produce, that 25% loss in quality is a steep cost to pay, even if you are saving money in labor costs. Even worse, it creates an opportunity for a competitor to swoop in and gain market share. You can’t enshitify everything and not expect someone to figure out that people will pay more for better. AI can’t produce that “better”, but a talented human (probably with AI) can.

AI has a major trust problem. In the course of writing this post, I had a long, very long conversation with AI about its strengths and weaknesses, as well as the themes described in the Citrini piece. At multiple points during that conversation, even when prompting it to “promote correct responses over social cohesion” or just “please don’t be a sycophant and agree with me”, the agent bounced back and forth, straining to do exactly what I asked it to do, pressure check my answer, and play devil’s advocate, and agree with me. It just couldn’t help itself, even at one point telling me that it had become confused and was struggling not to read between the lines of my prompts for a deeper meaning that it could align with. It just couldn’t stop being a people pleaser, which makes it extremely unreliable without human guidance to ask the right questions.

The mass layoff —> wage deflation —> spending collapse is unlikely. For all the reasons listed above, the dreaded super productivity boost, where AI essentially puts everyone out of a job, which causes a collapse in household spending and an economic crisis that the Fed is powerless to stop, isn’t even a credible tail risk. There will be economic losses, but there will also be gains. Those kinds of offsetting shifts are exactly what have happened in all previous periods of rapid technological advancement. It unfortunately creates winners and losers. But in aggregate, it’s unlikely to do enough damage to tip the entire economy into a prolonged period of depression and economic stagnation, as the Citrini scenario implies.

It still could cause economic damage, especially to vulnerable groups. Just because we don’t all end up on a palladium farm mining for our robot and uber-capitalist overlords, doesn’t mean that there won’t be economic consequences. While a macro-level liquidity trap is extremely unlikely, a regional one or industry-specific pain is probable. Programmers are likely to face a permanent downshift in demand for their labor. SaaS companies, particularly those that serve as admins and assistants for rote tasks, are likely to be squeezed or driven to extinction. And the greatest risk is that young workers will fall behind, creating economic instability for those unable to adjust and robbing companies of a pipeline of talent, unless, of course, they invest in training the future - one of our keys to surviving the AI fallout.

Don’t sleep on the dangers of AI group-think. It’s true that two users asking AI a similar question are likely to get two different answers. But that doesn’t mean the underlying process of arriving at those answers is completely different. AI is energy-minimizing and searches for the quickest approximate answer. If you prompt it to dig deeper, it starts by reading every source it can find, trustworthy or not. Narrow down the search to only respected sources, and it’s very likely that you’ve reduced the range of inputs down far enough that if two people, or 1000 people, were asking the same question, they’d get a very similar process. Groupthink is already an issue with humans, but adding a seemingly all-knowing black-box machine that will take a stab at answering any question you throw at it will lead to groupthink, which, as we saw in 2008, can lead to catastrophic economic events.

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NY Fed President Williams ended the fight - a rate cut is coming. It shouldn’t be a surprise to anyone when the FOMC decides to cut the federal funds rate by 25bps tomorrow at 2:00pm Eastern. John Williams, one of the most intentional communicators and influential members of the Committee, said as much three weeks ago. Half of the Committee has expressed concerns over inflation, but Williams comments, which normally aren’t so telling, are a sign that the rate cut will be pushed through, even with a likely three dissents. That’s partially because…

The inflation data are playing ball, finally. It flew a bit under the radar, but last Friday’s PCE inflation data showed that, so far, the impact from tariffs has been less than many expected, and inflationary pressures may have peaked in April. The monthly pace of core PCE inflation - price growth excluding food and energy, which is the Fed’s preferred inflation gauge - has slowed in each of the last three months. The yearly change in inflation, which is what makes most of the headlines, will remain elevated until we get the January data due to statistical technicalities called base effects, but the clear easing in the monthly pace of price growth provides cover for timid hawks who may be queasy about inflationary pressure but not willing to stir the pot with a full revolt in December. Don’t get caught flat-footed staring at the yearly change in inflation. The action is happening at the monthly level.

2025 > 2026 in upcoming fed forecasts. December will bring the FOMC’s last Summary of Economic Projections (SEP) for 2025. Unsurprisingly, forecasts are decent this time of year. The summer data showed an economy that is growing at a strong pace, and what little data we’ve received over the fall has dispelled fears that the economy is currently in a recession. Growth likely slowed in the final quarter, and we’re entering 2026 on very shaky footing, but the economy’s solid performance in 2025, especially given all the chaos, is likely to show up in the December SEP as higher growth and lower unemployment in 2025, with lower inflation. However, expect to see some downgrades for 2026 as storm clouds continue to gather on the horizon. Our table below lays out exactly how we expect the SEP forecast to change in tomorrow’s release.

Three things to watch at tomorrow’s press conference:

1. Did the recent inflation report change any minds? Did the recent improvement in the inflation data assuage the concerns of any hawks? Expect Powell to sound a little less hawkish than he did in October if the data were only a little persuasive. However, he might explicitly state that members were less worried about inflation if a tidal wave of relief overtook the Committee. The latter would have implications for January.

2. Which labor market data did they find more compelling? Another interesting storyline that has gotten less attention is the discrepancy between the private and public labor market data in September. Data from payroll provider ADP showed a contraction of 32k in private sector employment in September. However, the official Bureau of Labor Statistics (BLS) data showed that the economy added 119k jobs in the month. That data is likely to be revised down, but not by a 120k. The BLS won’t report data for October, and ADP showed a rebound, but a question is like to surface on which data series carried more weight at the December meeting.

3. How worried are policymakers about “financial market plumbing”? There have been signs that that the banking system may again be short on reserves and liquidity. Those issues caused a spike in the repo rate back in September of 2019, and there are whispers that policymakers overdid it on quantitative tightening. A question about “financial plumbing” is almost guaranteed to come up, and Powell’s reaction will be a telling sign on whether the Fed is worried they made need to step in next year to assure smooth market functioning.

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Earlier this month, former Fed Governor Adriana Krugler stepped down unexpectedly, giving the administration an early nomination to the Board (her term was up in early 2026). As we outlined in our last FOMC Download, Governor Kugler's resignation will do nothing to quench the administration's thirst to undermine the central bank's independence. In fact, it likely made them even more thirsty. We’ve long held the belief that this administration operates under schoolyard rules. In that world, you give up your lunch money, and they come back for your backpack. As Powell has made abundantly clear for months, he and the FOMC aren’t interested in giving up their lunch money.

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This is not a tactically sound strategy for Trump. We don't know the validity of the charges brought against Governor Cook, but there is a decent chance they are politically motivated, which is another hallmark of the current administration. We are confident that the Board and Governor Cook will do the right thing if laws have been broken. We are also confident that she and the Board will do the right thing if they have not been. Either way, it’s impossible to view this as anything other than an attack against an institution that has bucked and enraged the Trump administration. That’s a problem for both the Fed and the President. It’s clear why these constant political attacks against the Fed are bad for its credibility; we won’t rehash that here. But they are also tactically unsound if the president wants to maximize his Fed influence. Each nakedly political attack creates an incentive for the FOMC to exhibit its independence. Will policymakers vote to keep rates elevated solely to show the world that they are still independent? No. Policy will be driven by the economics and forecasts. But they’re also people. Will a fence-sitting member(s) of the FOMC be pushed to hold firm because they don’t like the optics of central bankers being pushed around by politicians? Maybe. And it would be a sound economic move. The independence of a central bank is foundational. Lose that, and the game is over. That’s why restraint and patience would be a better strategy if the president wanted to maximize his Fed influence.

Trump is all but guaranteeing that Powell stays on as a Governor. Powell’s term as FOMC Chair ends next May, but, crucially, his term as a governor on the Board of Governors doesn’t end until January 2028. Traditionally, when a governor is not renominated to be Chair, they resign their governorship and open up a position for presidential appointment. The Fed is an institution steeped, and I mean absolutely steeped, in tradition. It takes a historic shock to change the central bank’s DNA. I say that as someone who has worked at high levels of the organization. And so, I don’t say this lightly, but there is very little chance that Powell resigns his governorship next year when his term as Chair expires. The institution is facing an existential threat aimed at undermining over a hundred years of policy. We know this. Powell knows this. Children in preschool know this. What is less obvious is the quiet resolve with which Jerome Powell carries himself. That is not an endorsement of his time as Fed Chair. It is a fact. While seemingly mild-mannered, Powell is not one to be pushed around. And he will not let the institution crumble if he can help it. That means Trump’s overt and relentless attacks against the Fed are going to push him to buck tradition and stay on as long as he can. There’s little question that Powell would have stepped down next year had Trump remained patient and quiet. Instead, he scored an own goal that will further frustrate a president who is unaccustomed to not getting his way.

No, this doesn’t put the regional presidents at material risk. Reports are circulating that the administration is targeting Board governors to get at the more insulated regional Fed presidents. As a quick recap, the FOMC consists of 19 members, seven Governors in DC, and 12 regional bank presidents. Of those 19, 12 vote on policy with the seven governors in DC and the New York Fed President (John Williams) voting every year. The remaining four voting slots rotate annually between the other 11 regional presidents. Presidents nominate Board Governors, but they have no direct authority over regional presidents who are chosen by regional bank Boards comprised of banks and businesses in each district. Here’s the rub. If a president has enough influence with DC Board members, they could theoretically influence the selection of both the regional Boards and the regional Presidents. How? The Board in DC has to approve both regional board members and regional Fed presidents. Historically, those have been rubber stamps. There’s another wrinkle. Regional president terms expire every February in years that end in one and six. That means that if Trump packed the Board with loyalists, they could potentially upend tradition and deny the “automatic” reappointments. To do that, he would need to have four Governors willing to completely undermine the credibility of the institution. If Cook steps down, you could credibly argue that there are two. The administration has proven, many times over, that it puts a premium on loyalty. It’s fair to say that any nominee from the second Trump administration would be willing to flip the table and cause chaos if the President wanted it. But they’d need two more to actually get it done. Some news outlets have lumped in Governors Waller and Bowman, two Trump appointees from the first term, with Miran and another potential Trump pick. But that is unfair and unfounded. Waller and Bowman have shown no signs of wanting to upend the order. They may both be gunning for Powell’s chairmanship, but there is no evidence they’d be willing to end fed independence to get the job. Until they show clear signs that they’re willing to go against their previous actions, it should be assumed that they are not loyalists in the same way that Miran is likely to be. In other words, the regional Fed presidents are safe for now. And monetary policy can continue to be driven by economics and forecasts.

It’s undeniable that the Trump Administration has damaged the Fed. But, we’re not yet at a place where we should be assuming that we’re a nomination away from undoing modern economics.

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There are good data-driven arguments for a September cut. And there’s no question that the July employment report, with its huge downward revision to job gains this summer, is a sign that the labor market is even weaker than we all thought. But this morning’s CPI release was an argument against rate cuts, not for them.

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Monthly inflation is heating up before Labor Day. Let’s start with the facts. The monthly inflation rate for core CPI was 0.322% in July. Is that hot? Ab-so-lut-ley. The monthly rate associated with 2% inflation over 12 months is 0.165%. July was nearly double that. another way of thinking about that is if inflation ran at the same rate for 12 months that it did in July, the yearly inflationary rate would be 3.6%. Is that 1980s chaos inflation? Nope. But it is both well above the Fed’s target - core CPI of 3.6% implies that core PCE would be above 3.0% - and it’s moving in the wrong direction. As the figure below shows, it’s not just the CPI data. The pace of monthly core PCE data has been rising since May.

Tariffs weren’t the only reason inflation popped. There were signs that tariffs are having an impact. Prices for used cars rose at a decent clip, as did prices for apparel and household furnishings. But it wasn’t all tariffs. Prices of medical care services were hot, and inflation in the transportation sector hit 1.0% m/m. The volatile category of airline fare jumped 4.0%. Overall, services less energy inflation rose by 0.4% (that’s up from 0.3% in June and 0.2% in May. Shelter inflation is down from its post-pandemic heater, but it’s still rising at a healthy clip, and that’s with the most unaffordable housing market in generations. I’m not sure what everyone else was looking at, energy prices did decline *golf clap*, but this was fairly widespread, which will be hard to argue are “one-time tariff” shocks.

Forecasts for July core PCE are probably too low. For much of recent history, the monthly change in core CPI has nearly uniformly outpaced the monthly change in core PCE. Things changed a bit after the pandemic. Core PCE started to outrun core CPI more often. This year, that dynamic has been even more pronounced. Four of the six months for which we have both core CPI and core PCE data had the monthly change in PCE > CPI. Things can always reverse, and some of the hot categories in the CPI release, like airfares and medical care services, are calculated differently in PCE, but the latest CPI data points to a hot core PCE (the Fed’s preferred measure) at the end of August.

I know, we’re a broken drum, but yearly inflation is about to stall out. We’ve been talking about this for a while: the 12-month change in core PCE inflation, the Fed’s preferred measure of inflation, is about to stall out in the second half of the year. The reason is something wonky called base effects - the reference point for the 12-month change is messing with the numbers. Given the current state of the labor market, policymakers might have been willing to overlook this as inflation relief is coming early next year, were it not for those hot monthly readings. There’s a real risk that inflation stalls out above 3.0%, above last year’s stall out. If we stack a couple of hot monthly readings together (and let’s not forget all of this data is for the period before the August round of tariffs) and inflation could hit 3.25% by the end of the year. Again, that’s not end of the world stuff. But it is significantly hotter than last year and will make key hawkish members of the FOMC pause.

No, the labor market data didn’t change much. There was a collective freakout after the downward revisions to job gains in May and June. Some of that is fair. It was one of the largest combined revisions on record. It emphasized just how shaky conditions in the labor market are at the moment. But that is not new information. Sure, they’re even more fragile than we thought, but they’re not dire. Recessions are accompanied by large job losses. Even if you can’t see them in real-time, as we pointed out in a March labor market post, real-time employment data during the onset of the 2001 recession was volatile and unclear, slower job growth is not a recession. The economy still added 73k jobs in July. Yes, a lot were in healthcare and social assistance; this year, that sector has accounted for almost 79% of all job gains, but it’s not yet a crisis.

The Fed isn’t going to spike the ball just yet. The labor market is fragile, and it may still fall off a cliff, but it’s going to take that for key policymakers to walk away from their commitment to 2% inflation after they missed the boat in 2021 and 2022. Powell keeps saying it: the best thing they can do for a stable economy is bring inflation back to 2%. When someone tells you who they are, believe them.

There will be some dissents, but the Fed is going to make sure either the labor market is a dire place, or inflation is sustainably back down to 2.0%, before they start the end zone celebration.

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That’s all great news, but we’re not entirely out of the woods. The full impact of the April trade bomb hasn’t arrived yet, suggesting that we’re heading for another economic soft patch in Q2. There was also a metric ton of investment in Q1, much of which was pulled forward as businesses tried to get ahead of tariffs - hello 115% investment in computers and peripherals (see chart below). Expect less investment spending going forward, and maybe less consumer spending. That may lead to another quarter of economic contraction, but it probably won’t lead to a recession unless the economy starts shedding jobs. And we’re not there yet.

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Inflation is a real wild card. Like all things 2025, the inflation data may be breaking tradition. The latest PCE data showed almost no core inflation from February to March. That was right before “Liberation Day,” so we’ll be closely watching the April Personal Income and Outlays report when it comes out later this week. But even that might be too soon to see an inflationary impact. There are many news reports of businesses trying to ride out the tariff wave with only moderate price increases, or eating into corporate profits, so it’s likely that the inflation boost from tariffs won’t arrive until June or July. In any event, the latest news has been disinflationary, which lowered the inflation trajectory in both of our scenarios. Even with that improved forecast, the Fed still might not be able to lower much, if at all, in 2025, if we avoid a recession.

Fed may still be on hold for a while. A lot is going to depend on the next few inflation reports. If we get more disinflation with very low monthly price changes, we’re likely headed for a 25bps cut in September. But that’s optimistic in our view. As we noted above, the tariff impact hasn’t been felt yet. And it’s going to come at a bad time. Just like last year, the 12-month change in core PCE inflation - the Fed’s preferred target - is poised to stall out in the second half of the year. The reasons are technical; they’re called base effects, but unless we get very soft month-over-month readings in the second half of the year, inflation will remain above the Fed’s target in 2025. And that’s with a whole lot of uncertainty around tariffs. If the labor market continues to hold up, and right now it looks like it will, the Fed will be hard pressed to find room to cut until early 2026. Eventually, rates will come down further - economic fundamentals point to another 75bps-100bps in total cuts, but those changes are a way off in a year where chaos reigns. Oh, and we have a potentially very expansionary budget bill set to arrive this summer. Policymakers have their work cut out for them, which unfortunately is the new normal.

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This shouldn’t come as a shock if you’ve been reading our research. So, instead of digging into the specifics of what was said or what was meant, the short answer is not much and nothing; we’re going to dive into the latest data and what it would take for policymakers to start lowering rates. As we’ve discussed in previous notes, even the best macro data is backward-looking and misleading in real-time. And we don’t have reliable forward-looking indicators, which means that the Fed will likely be in a holding pattern for a while, unless the boat really starts taking on water.

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Cooling inflation is probably a head fake. While the March data was encouraging, there were signs that it’s still far too early to pop the champagne. As the chart below shows, the revisions in the prior two months, January and February, were sizeable. So much so that even with the five-year low in the monthly rate, the three-month moving average was essentially unchanged from February at 0.29%. In other words, it’s still unclear if the March core PCE numbers were the start of a new trend or a pre-tariff mirage.

Perhaps the most troubling part of the March inflation data was that it came out before the April 2^nd announcement of “reciprocal” tariffs. The January and February inflation readings look very much like a runup in prices before the implementation of additional tariffs. In that context, a March lull makes sense. However, that cooling is likely to be met with at least a moderate uptick in inflation in the coming months as companies begin to pass along the trade war costs to consumers. The good news is that the recent de-escalation on Chinese tariffs and the concepts of a trade deal with the UK suggest we’ll avoid what could have been a historical surge in inflation. The bad news: 30% levies on Chinese imports are still significant and disruptive, we don’t yet know what any of the trade deals will look like, they could be reversed, and the inflationary impact of previous hostilities still hasn’t landed on U.S. soil. The big meteor didn’t strike, but we still may get hit by a barrage of smaller asteroids.

The recent trade news means less risk to employment. The labor market was resilient in April. Employment grew by 177k (220k after adjusting for weather), and the unemployment rate flat-lined at 4.2%. Job gains remain somewhat concentrated, although less so than last year, and the number of people working part-time but would like full-time work and those not in the labor force who want a job held firm at prior levels. It wasn’t a perfect report, but it was hard to find much to worry about.

The trade war didn’t affect April's data meaningfully because the Bureau of Labor Statistics (BLS) survey took place the same week that “reciprocal” tariffs were implemented. The BLS survey always occurs in the week of the 12th of the month, which in April, was a Saturday. That meant that the survey was released on April 7^th and concluded on April 11, not even enough time for the market to fully grapple with the tariff impact, let alone Main Street. And as we discussed in our March Labor Market Watch, employment data can be revised significantly in real-time, making it hard to separate the signal from the noise until well after impact.

The bar is still high for the Fed to cut rates. Even if the trade war effects are less severe and more temporary than was expected a month ago, recent events will still lift prices for many goods. With inflation still above target and trade policy uncertainty persisting, albeit at a lower level, policymakers will be cautious about reducing rates when job growth is strong. As Powell said, they won’t be rushed.

Ironically, the trade war de-escalation may end up making a June cut less likely if the inflation data rebounds as we expect, as the probability of a recession in 2025 is now much lower - a change that’s reflected in our May economic and financial market forecast suite. Policymakers are still likely to lean into the employment data when assessing the non-inflationary economic impact from the remaining set of tariffs.

Given the historical real-time chop in employment data, we believe policymakers will wait for proof that the monthly pace of inflation has cooled at levels near 0.165%, or for the labor market to contract by more than 100k jobs in consecutive months, before deciding to resume rate cuts in 2025.

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It would be nearly impossible for Trump to erode the Fed’s monetary policy independence.

The Trump administration's removal of Democrats from the boards of the National Credit Union Administration (NCUA), the FDIC, the FTC, and the SEC has raised alarm bells that the President may try to do the same thing to the Board of Governors of the Federal Reserve System (the Board).^1,2 These fears were ratcheted up this week when Treasury Secretary Bessent said on a Bloomberg TV interview that the Administration thinks “about [replacing Chair Powell] all the time³,” and when the President posted to social media that Powell’s “termination cannot come fast enough!⁴” Central bank independence is the foundation of monetary policy. The erosion, or even perception, that the Fed is responding to the desires of the White House or Congress would put the price stability mandate at significant risk and cause turmoil in financial markets. Thankfully, the decentralized nature of the Federal Reserve System (the System) and the firmly held belief by all Fed policymakers that central bank independence is sacrosanct make it nearly impossible for the administration to influence monetary policy.

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Hurdle 1: The size, composition, and culture of the FOMC

The Federal Open Market Committee (FOMC) is the committee inside the Fed that sets the federal funds rate. It consists of 12 voting members, with seven alternate members who attend meetings and vote on a rotating basis.⁵ The seven governors who sit on the Board of Governors (the Board) in Washington, D.C., and the New York Fed President, currently John Williams, are permanent voters. The remaining four voting spots rotate annually between the other 11 regional presidents in either a three- or two-year cycle.⁶ Nonvoting members also attend meetings and share their views on the economic outlook, monetary policy, financial markets, and regulation. That’s an important dynamic as the culture of the current FOMC is one of collaboration – this has not always been true, see Greenspan, Alan – and thus, members can exert influence even if they are nonvoters. The decentralization of the Federal Reserve System (more below), the size of the attending member pool – 19 members – and the now ingrained culture of collaboration, are powerful forces that would push against even a small group of policymakers willing to erode monetary policy independence. Each member still only gets one vote, and as discussed below, presidents and governors have long terms. Many of the most influential policymakers have been on the FOMC for years and came up in the System as economists. They will preserve the culture of independent thought and dissent even if the administration nominates a new governor and/or Chair of the FOMC.

Hurdle 2: Decentralization, the Fed’s superpower

Before discussing the details of how governors and regional Fed presidents are selected, it’s essential to understand how the Federal Reserve System is structured. The belief in decentralization underlies the entire Federal Reserve Act of 1913, which established the Federal Reserve System.⁷ The System is split between the Board in Washington, D.C., a “.gov” web address, and the 12 regional banks, which are “.org” web addresses. Each regional bank is “separately incorporated and has its own board of directors⁸.” Those are important distinctions, as the seven governors who comprise the Board of Governors are nominated by the President and approved by Congress, while the 12 Reserve Bank presidents are not. They are selected by a group of directors from the Reserve Bank’s head office board. That means the president would need to influence a group of business and bank leaders with no formal ties to Washington, DC, in different parts of the country. Some may argue that it is still technically possible for an administration to influence small groups of business leaders across the country. We’d respond, “not with how those boards are selected.”

Each regional board comprises three classes of directors: A, B, and C. Class C directors are chosen by the Board of Governors in Washington, D.C., which also designates the Chair and Deputy Chair of the Reserve Bank’s board. In practice, that process is usually bottom-up, with the regional banks suggesting candidates to the Board of Governors. Those suggestions are traditionally respected. Class A and B directors are elected by the member banks in each Federal Reserve District. Each class consists of three directors for a total of nine Reserve Bank directors on each head office board, two-thirds of which are elected. The process for selecting a new regional bank president is undertaken by Class B and C directors⁹, half of whom are elected. In other words, even if the Trump administration were able to influence the Governors in D.C. to select three Class C directors who want to undermine the Fed’s monetary independence, they would have to influence or override the will of three other directors who were elected in a democratic process far from Washington. And even then, that would be just one regional fed president out of 12. And that’s before we get to the structure of terms for both regional bank presidents and members of the Board of Governors.

Hurdle 3: Overlapping and long terms, everywhere

Bank presidents and governors have long terms spanning multiple U.S. presidential administrations. Governors serve 14-year terms, with one term opening up every two years (in even-numbered years).¹⁰ That means the Trump Administration will only be able to nominate two new governors: in 2026 when Governor Kugler’s term expires, and again in early 2028 when Powell’s term ends (assuming he doesn’t step down sooner). In other words, the administration will only directly influence two of the 19 FOMC members.

Regional bank presidents “can serve until they are 65–unless they are appointed after 55, in which case they can serve for a maximum of 10 years or until they’re 75, whichever comes first.”¹¹ The terms for three Reserve Bank presidents are set to expire after this year: Thomas Barkin (Richmond, January 2028), John Williams (New York, June 2028), and Mary Daly (San Francisco, October 2028).¹² Anna Paulson was just appointed the new president of the Philadelphia Fed when for when Harker steps down at the end of June.

Again, the selection process for the Bank presidents is decentralized and outside the direct influence of D.C. But even if the administration was able to coordinate on a massive scale, they would only be able to seat three more FOMC members, all of whom would be appointed in the final year, or months, of the Trump administration. Add in the two Board openings that expire during his second term– one is again in the final year of his presidency – and it would still only yield, at most, five sympathetic officials out of 19, two of whom don’t even vote every year. It will take more than that to shift the culture of an FOMC that we believe would show little deference, and perhaps even resist, colleagues who do not believe in the foundational importance of central bank independence.

Hurdle 4: The market reaction

The market reaction to a U.S. President trying to force out the Chair of the Federal Reserve would be apocalyptic. Last week, a near meltdown in the Treasury market forced Trump to walk back most of his “reciprocal tariffs”. Moving against Powell would be a “hold my beer” moment that would wreak havoc on markets and the dollar. The flight of capital would be severe and, paradoxically, lead to tightening financial conditions as demand for Treasurys plummet and yields soar, the exact opposite of what Trump is trying to accomplish by removing Powell. We believe the pain would be so swift and severe that the President would be forced to walk it back immediately or face a systemic financial event. While his darker instincts and some advisors may be girding for a fight, some inside the administration still understand the consequences of rattling markets so severely ¹³

It's unlikely but not impossible that Trump can fire Powell

It may be impossible for Trump to stack the Fed deck in his favor, but he still may be able to go after King of Hearts. The Federal Reserve Act was amended in 1935 to allow U.S. presidents to fire Fed governors for cause, which has been interpreted as “inefficiency, neglect of duty or malfeasance in office.”¹⁴ It’s an ambiguous statement that leaves room for interpretation, and it appears to be getting wrapped up in a case currently in front of the Supreme Court in a case that addresses the legality of Trump’s decision to fire two board members at other independent agencies. Those board members challenged, and the issue has reached the Supreme Court. One line of thinking is that Powell may be at risk if the Court overturns precedent and gives the administration the authority to control independent bodies. Still others believe that even if the Court rules in the President’s favor, the justices may decide to put in a specific carveout for the Federal Reserve. We don’t have a clear view of which scenario is more likely to unfold. Either way, we don’t believe it would significantly erode the Fed’s credibility.

Unfortunately, it may already be too late to avoid a market reaction. Equities and Treasurys would take a dive if the Supreme Court even hinted at the possibility that a U.S. President could remove a Fed Chair. Eventually, things would settle as market participants realize that monetary policy would be mostly unaffected, and that litigation would likely mean that Powell would be able to finish out his term as Chair (he can buck tradition and remain a governor until 2028 if he is not renominated as Chair). In other words, we may already be heading down a path that doesn’t have an easy exit, but the consequences aren’t likely to be as severe as they initially seem.

References

1. Peck, Emily. “Trump Fires Democrats from Key Regulator, Stoking Fears about Fed’s Independence.” Axios, April 16, 2025, sec. Sneak Peek. https://www.msn.com/en-us/money/markets/trump-fires-democrats-from-key-regulator-stoking-fears-about-fed-s-independence/ar-AA1D3fbi?ocid=BingNewsSerp.

2. Goldstein, Steve. “There Are New Fears about Fed Firings after FTC Dismissals. What Analysts Are Saying.” MarketWatch, March 19, 2025, sec. Markets, Need to Know. https://www.marketwatch.com/story/trump-and-the-fed-are-getting-along-but-now-there-are-new-fears-about-firings-0024f7b9.

3. Pisani, Joseph. “Stock Market Today: Dow Drifts Lower; Global Markets Gain.” Wall Street Journal Live Updates - April 15, 2025, April 15, 2025. https://www.wsj.com/livecoverage/stock-market-trump-tariffs-trade-war-04-15-25/card/bessent-thinks-about-next-federal-reserve-chair-all-the-time--mrO9ze5OobYJhFcNuu4p.

4. Trump, Donald. “Social Media Post.” Truth Social, April 17, 2025. https://truthsocial.com/@realDonaldTrump/posts/114352766082542122.

5. Board of Governors of the Federal Reserve System. “About the FOMC.” Federal Open Market Committee (blog), n.d. https://www.federalreserve.gov/monetarypolicy/fomc.htm.

6. Federal Reserve Bank of St. Louis. “The FOMC Voting Rotation, Explained.” Blog. Open Vault Blog, November 16, 2022. https://www.stlouisfed.org/open-vault/2022/nov/fomc-voting-rotation-explained.

7. The Board of Governors of the Federal Reserve System - About the Fed - Federal Research Act. Section 2. The Federal Reserve Districts. “The Federal Reserve Act,” n.d. https://www.federalreserve.gov/aboutthefed/section2.htm.

8. “Who Owns the Federal Reserve?” FAQs, n.d. https://www.federalreserve.gov/faqs/about_14986.htm.

9. “Overview: Federal Reserve System Boards of Directors.” About the Fed - Federal Reserve Banks, n.d. https://www.federalreserve.gov/aboutthefed/directors/about.htm.

10. Board of Governors of the Federal Reserve System. “Board Members.” About the Fed, n.d. https://www.federalreserve.gov/aboutthefed/bios/board/default.htm.

11. Wessel, David. “Who Has to Leave the Federal Reserve Next?” Brookings Commentary, March 17, 2025. https://www.brookings.edu/articles/who-has-to-leave-the-federal-reserve-next-2/.

12. Op. cit

13. Messerly, Megan, and Victoria Guida. “Bessent Privately Urges Caution as Trump Attacks Powell.” Politico, April 17, 2025. https://www.politico.com/news/2025/04/17/trump-powell-fired-fed-00295552.

14. Timiraos, Nick. “Can Trump Fire Fed Chair Jerome Powell?” Wall Street Journal, April 17, 2025, Markets Coverage (Live Blog). https://www.wsj.com/livecoverage/stock-market-trump-tariffs-trade-war-04-17-25/card/can-trump-fire-powell--JXhx7p7R8Qdi2E1X0pmF.

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If the economy is more resilient than we estimate, we still expect a significant slowdown in growth - with a quarter of contraction in real GDP growth - in 2025.

No, this isn’t a fire drill. Break glass.

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Walking it all back is unlikely and it’s probably too late. A lot of ink has been spilled on the reasons why the Administration would come out of the gate so forcefully on tariff policy. We won’t speculate on causes, or find fault with methods, but given what happened with the early March tariffs on Canadian and Mexican goods, we view the White House as serious as a heart attack on tariffs. The good news is that Trump delayed enactment on goods covered under the USMCA, a trade pre-existing trade agreement with Canada and Mexico. That suggests that a component of the “reciprocal” tariffs is a negotiating tactic, but it is unclear how much and what the conditions are for removal. Over the weekend, President Trump reaffirmed that other countries need to close their trade deficit with the United States. We view that as an unrealistic objective. Even narrowing a trade deficit will take time. Further uncertainty was thrown into the mix, when the White House refuted reports that Trump is considering a 90-day implementation pause. Every headline causes more confusion.

While we think that negotiation and armistices are likely, we are concerned that there isn’t enough time to negotiate with every major trading partner - let alone every country - before enactment of the larger round on April 9th, or in time to stop the impact of the blanket 10% tariffs that went into effect on Saturday. And even if wide agreement could be reached quickly, the psychological damage to consumers and businesses has already occurred. No matter what, prices will rise in the near-term, and households and businesses will pull back on spending until the shock wears off and tensions subsided.

Inflation will surge. There’s no good way to say this, inflation on most things is about to pick up. The monthly change in core PCE was much too fast in February, a point that has been lost in all the tariff hoopla. And that was before the widespread explicit tariff announcements. As Figure 1 shows, our model has inflation reaching 3.7% in a mild downturn and almost 4.4% if we avoid a recession.

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The Fed may have to raise in 2025. The world changed on April 2nd. The announcement of widespread tariffs came on the heels of data showing that some measures of inflation expectations are starting to head north. We’re not in a world of unanchored long-run expectations yet, something that would be game over for the Fed, but the latest round of tariffs will add a lot of fuel to the fire. We still expect policymakers to react by cutting rates should the economy hit a recession (again, we think that is likely). They’ll just do a lot less than they otherwise would have. If the economy outruns the chaos, we think there’s a good chance that policymakers will be forced to raise later this year. Core inflation approaching 4.5% with expectations heading higher, coming out of a historic inflationary period where the Fed fell behind, will be too much for policymakers to ignore. We don’t think they’ll go overboard with it, but we do think they’ll have to react. That’s going to complicate matters and send markets into a tailspin. In other words, 2025 is just getting started.

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Expect deterioration in the economic forecast. The FOMC releases a set of economic projections four times a year. Each member submits a forecast for growth, the unemployment rate, headline and core inflation, and the appropriate trajectory of monetary policy over the next couple of years. The table below is what we expect to see in the March projections. We anticipate an across-the-board deterioration in the economic forecast (lower growth and higher inflation) and fewer interest rate cuts in 2025 and 2026.

If it walks like a duck and talks like a duck…There’s absolutely no chance that Powell, or any policymaker, uses the word “transitory” when talking about the impact of tariffs, but given how they affect the economy, it’s likely that’s what the projections will suggest. Tariffs are a one-time price shock, with the inflationary impact front-loaded around the time of announcement/implementation. In theory, prices should move up quickly and then stabilize unless, of course, there are more tariffs. The Trump Administration’s continuous tariff threats and rolling window of implementation elongates that impact significantly. It’ll be interesting to see what the projections reveal about FOMC members’ views on the duration of the trade war, but overall, we believe they’ll view it as something that lasts through the end of 2025, with some inflationary impact in 2026. That’s how you say transitory without saying transitory.

They’ll say the labor market is fine. One of the more interesting economic stories of 2024 was the rapid summer shift from concerns over inflation to labor market worries after a soft patch of late mid-summer data. Powell went so far as to repeat, on more than one occasion, that he personally didn’t want to see any additional cooling in the labor market. Then inflation picked back up, and we all moved on. But below the surface, there has been additional deterioration in labor market conditions since the fall. We expect Powell, and others, in their post-FOMC comments will do their best to avoid showing concern about the recent labor market data. That’s not because they’re not worried; it’s because we’re standing on the edge of economic contraction, and they don’t want to speak it into existence.

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Focusing on GDP will leave you behind. While there are no reliable recession predictors, some data is more accurate in assessing whether the economy is already in a recession. For instance, the favorite back-of-the-envelope metric by many is two consecutive quarters of economic contraction. There are, however, issues with this popular method. First, the data is not timely. The advanced GDP release (first) for any quarter comes out at the end of the month after the quarter ends. In other words, we won’t get an official read on 2025:Q1 GDP until the end of April. Second, two quarters are needed to make an unofficial recession call. The earliest that could be done would be at the end of July, when the advanced release of Q2 is scheduled to be released. If the economy enters a recession in March or April, the GDP data wouldn’t be definitive until July, at the earliest. Sure, there may be some indication in April if Q1 shows a contraction, but as 2022:Q1 showed, there are times when a quarter contracts and the economy is just fine.

The labor market data doesn’t help much in real time. Since quarterly data is often too lagged to help identify a recession, economists prefer to focus on monthly labor market statistics, which are both high-quality and relatively timely, particularly changes in aggregate employment (job gains/losses). While the data comes out more frequently, significant real-time issues persist. The data can be revised, sometimes substantially, in the two months following the initial release. That can make it difficult to see the consecutive months of job losses that usually accompany a recession. To assess the accuracy of employment changes in correctly identifying a recession in real time, we looked at the revisions to employment changes over the last 45 years in both expansions and contractions.

Jobs data was behind the curve in the 1980s. There have been five economic downturns since 1980. The first two were in 1980 and 1981-82. In both cases, the initial data did not record job losses until the second month of the recession. The picture became more apparent after the fact as the first month of data for the 1981-82 recession was revised a year later to show a loss in overall employment. The same was not true for the 1980 recession, as the economy was still estimated to have gained jobs in the final print of the first month.

The 2001 Head fake. The data was more accurate during the 1990-91 and 2001 recessions. In both episodes, the economy appeared to lose jobs in real-time in the initial month of both recessions. However, there was a head fake during the 2001 recession as data revisions to the second and fourth months of the downturn were initially revised from job losses to growth. Only after the final revision a year later did it become clear that the economy posted consecutive job losses during the early months of the recession (See Table 1). Given the contours of today’s economy, we believe a recession in 2025 would look like the one in 2001, with more inflation.

Messy real-time data is going to make it hard for the Fed. The speed of policy change is accelerating. Consumer confidence appears to be in freefall as the trade war escalates. We’ve avoided a government shutdown but have a massive budget fight ahead. And we’re still trying to figure out what the federal government, companies and organizations that do business with it, will look like after the dust settles on the DOGE cuts and funding restrictions. There’s a lot for businesses and households to digest, and most of it isn’t good news. Just don’t expect the next couple of labor reports to shed much light on whether the economy has entered a recession. It probably won’t be clear until much later. That lag and rising inflation expectations is why we think the Fed may be late to react to the incoming recession.

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The policy response will sound a lot like crickets: The Fed and federal government probably won’t be able to do much initially to lean against a downturn. Tariffs, or even the threat of tariffs, and continued pressure on some supply chains mean inflationary pressures are here to stay. We won’t get as much of an inflationary bump if the economy contracts, but we also probably won’t get much cooling either. That’s going to hamstring the Fed. Add in that economic data lags real world developments, and the stars are aligned for a late monetary policy response.

The federal government won’t provide much help either. Congress is in the middle of a budget fight, and the mood on the Hill is cost-cutting, not cost-expanding. If the economy turns, we’re not getting another round of stimulus, which could mean a sluggish recovery on the backend.

Job losses will spread to the private sector. Our monthly forecasts always include two detailed scenarios. This month, our baseline is for a mild stagcession. We’ve also gamed out an “upside scenario” where household spending slows and investment remains weak, but the economy misses a technical recession—not much of an upside, but it should tell how serious the risks are to our economy. In our baseline scenario of a mild stagcession, cuts in federal employment bleed over to the private sector, leading to significant job losses, as shown in Figure 2. Even without that, we expect employment cuts at federal agencies, and private sector companies that receive federal money, to equate to a full quarter of job losses later this year.

Congress could add insult to injury: The upcoming fiscal fight could hamstring the government’s ability to respond to a recession and apply upward pressure to market interest rates. The debt and deficit will jump even if Congress is able to pass the House budget with substantial government spending cuts, something we view as unlikely. And we expect they’ll decide to borrow more rather than walk back tax cuts if they can’t cut as much spending as they propose. That means the supply of Treasurys will jump over the next few years, weighing on bond prices, which raises bond rates. Talk about swimming upstream as the Fed is trying to cut rates.

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Why it matters: While job gains have been solid and the unemployment rate edged down recently, employment growth remains highly concentrated, and hiring remains anemic. A big shock to the labor market would threaten the core of the current economic expansion: household spending.

The worry is that the DOGE crusade will cause massive job losses, forcing consumers to pull back, thus weakening the most important pillar of the current economic expansion. Even with last night’s news that Trump has broadened DOGE’s mandate to undertake a reduction in force (RIF) at nearly every government agency, we don’t believe they’ll cut enough to seriously threaten the economy. That’s because the federal workforce is not an engine of employment growth.

It’s all about state and local jobs. As the figure below points out, federal job gains have been an afterthought over the last four years. During that period, the entire government sector added just over 1.9 million jobs, of which 127k, or 6.6%, were federal employment gains. That pales in comparison to the 423k or 1.36 million job gains in state and local governments, respectively. Under our “moderate cuts” scenario, we don’t expect current or expected cost-cutting measures to erase even those meager gains.

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What does this mean for the Fed? As this morning’s CPI report shows, inflationary pressures remain too hot for policymakers. A cut at the March meeting is off the table, and nothing DOGE is doing will put it back on. So don’t recalibrate your rate expectations yet.

Ok, but what about markets? After the dramatic pause in Canadian and Mexican tariffs, markets have more-or-less shrugged off news from the Trump administration. Many executive orders are being challenged in court, which will slow implementation and likely spread job losses over several months. That will mute the impact to any one employment report, which means markets will ignore it. The economic data will continue to be a driving force in market gyrations, not actions taken by DOGE.

What should I worry about? While federal job losses in isolation won’t tip the economy over, the wide range of inflation-inducing trade and immigration policies and unprecedented spike in murky executive orders are a risk to business investment and household spending. Nothing’s set in stone, and not all of these policies are a net negative on the economy, but many of them are not well understood and hard to model, and the interaction between them is impossible to predict. That’s going to make for a volatile 2025.

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Next up: Canada, Mexico, and the USMCA. Before the dust up with Colombia, Trump’s declaration that he would slap tariffs on Canadian and Mexican imports on February 1st dominated economic headlines. Our latest research note took a look at what the inflation implications would be if tariffs, as have been discussed, were enacted on our two largest trading partners. There is an email below if you’d like access to our analysis, but the abbreviated version is that it would create additional inflation and potentially cause the Fed to raise rates in the second half of the year. And what has the President asked for to avoid that scenario? He wants Canada and Mexico to stem the flow of drugs and people across our borders. But as the figure below points out, it’s odd to lump those two countries together. The Customs and Border patrol recorded over 15 times the number of encounters at the southern border compared to our larger northern border. From an immigration and enforcement perspective, these two borders couldn’t be farther apart. So why not save Canada and just go after Mexico? Because the President, always eager for quick wins, would like to renegotiate the USMCA trade agreement in 2025, rather than the previously agreed upon 2026 timeline. Canada and Mexico have every reason to acquiesce. And as we saw this weekend, when the President gets what he wants, tariff threats evaporate in a matter of hours.

The Fed may have to recalibrate in uncomfortable ways. If tariffs on Colombian imports would have been modestly inflationary, particularly for coffee which is already reeling from poor harvests in Brazil, tariffs on Canadian and Mexican imports could be game-changing for the Fed. As we started discussing last spring, growth in the Fed’s preferred inflation measure stalled out in the fall, causing policymakers to transform into hawks at the December FOMC meeting. Many are worried about the impacts of tariff and immigration policy on price growth. With the pace of deportations picking up and the increased use of tariffs as a threat creating a greater likelihood that someone will test Trump’s resolve, it’s increasingly likely the Fed will have to make some uncomfortable choices later this year.

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