At a time when the Federal Reserve’s mantra is “wait and see,” when few officials are ready to commit to policy moves in any direction until it becomes clear what happens next with President Trump’s tariffs and it’s clear how much they higher they do - or don’t - push up inflation, it’s a great time to hear from someone who is quite convinced about how this will play out. And cites evidence in the latest employment report to back it up.
Enter Kathy Bostanjcic, chief economist at Nationwide. She has been analyzing the the U.S. economy and what its twists and turns mean for the Federal Reserve ‘s policy path for more than four decades. She joined me at the conclusion of a job-report morning when she and her team had four-and-a-half hours to analyze on the all-important June employment report - and more - before Wall Street closed early ahead of the Fourth of the July holiday. And she was ready and raring to go.
Important to note that one of the most important economic reports the government releases each month, took on extra importance this month. Some key labor market data have begun to weaken. Many economists see the Fed tilting more than ever toward the jobs side of its dual mandate and less towards the inflation side. And to top it all off, one day before the release of the government’s jobs report, the ADP report, a closely-watched measure of jobs in the private sector, that private sector report (i.e. not-government jobs) had just reported an unexpected drop of 33,000 jobs in June.
So when the June jobs report showed payrolls not weakening sharply but instead rising a healthy 147,000 jobs, this cast a big question mark over what this would mean for the Fed. Especially when inflation is still running above the Fed’s 2% target, exceeding that level for four years now. And, this came just two weeks after the FOMC (the policymaking Federal Open Market Comittee) raised its median 2025 forecast for its key inflation indicator to 3.1%, leading many to wonder if the Fed will be able to cut rates this year, even as at least two Fed officials have already signalled they may be getting ready to vote for cuts as soon as July.
Kathy actually sees inflation rising as high as 3.5% but expects it to be temporary. She thinks the increasing number of discouraged workers reported in the June jobs report and the falling numbers of employed workers in the BLS’s househould survey are among the signals that when you look past payrolls that indicate the labor market is weakening. And importantly she sees the unemployment rate rising to 4.7% by the end of this year.
So dive in and hear why she sees the Fed doing at least 50 basis points of rate cuts this year, and a more than a 50% chance it will do 75 basis points of rate reductions by year’s end. There is a significant camp of economists also arguing for rate cuts this year. Kathy gives us a thorough look at the data, especially from the labor market, that support this.
Spoiler alert: Kathy does expect that after the stronger-than-expected June jobs report Fed officials who have recently indicated support for a rate cut at the July policy meeting will decide to back off - for now. But by September she forecasts the data will be weak enough for the Fed to start cutting rates with either a 25 bps cut in each of the final three meetings of the year or if necessary one cut of 25 basis points and one cut of 50bp.
Perplexing report- it’s more than the headline 00:02:14:23
Now, we all knew ADP and non-farm payroll didn’t move together month to month, but over time, they move together. And I think just that shock and there's a lot of uncertainty of how the economy is faring with the tariffs and all this uncertainty and the labor market slowing and if it is by how much? And then there are these restrictions have been put in place, with immigration. So so a lot of changes in inflows of supply of labor. And then there's a question about how much is really demanded. So a lot of churn underneath the headline numbers. So, you know, getting back to today's number, there's probably a little bit of in there for everybody, right? So if you were always right and thinking, oh my gosh, we may get a negative print, you're relieved… the headline number looks solid, but beneath that, there's some softening in the labor market.
The ADP print spooked the markets 00:03:18:08
So let's look at the ADP report. It's a measure of private job growth. It's not government jobs included here. And for the most part, it doesn't really predict what the payrolls are going to do. That's what we've learned over time. However, if you look at a chart, they kind of move together a direction, right, Cathy? If ADP is going up, payrolls are going up and vice versa if they're going down. But this time it was very, very striking to see this report all of a sudden negative. So how does this… affect people's analysis, even sort of reserve analysis if they see one that isn't the main number? Well, all of a sudden it got negative. And the bigger number, the historic number going up, what, 147,000 and some the median was something like what, 110,000 for the payrolls increase. Yeah, that's correct. So I think by and large the Federal Reserve is going to put more of the focus, as they typically do, on the non-farm employment data that's released by the Bureau of Labor Statistics.
Household and payroll reports are often at odds 00:04:23:12
However, like within the employment release, you get the household survey and you get the establishment survey. So, they establishment the survey, where we get the non-farm payroll report, again, that gets the most weight and importance. But what if you look at the household survey, even though the unemployment rate ticked down to 4.1% from 4.2, it was for the wrong reasons. Participation in the labor force is declining. And if you look at employment, especially in May, it really collapsed. It fell sharply. So rebound a bit and in June, the employment count. But in general, when you account for the drop in the labor force participation rate, if you held it steady at a few months ago level, the unemployment rate would be actually 4.7, not 4.1.
Ranks of discouraged workers grow…fog spreads 00:05:14:16
So what we're seeing is people are increasingly discouraged workers and they're just they want a job, but it's too tough to find one. So they're dropping out of the labor force and that that's not for a good reason. And in fact, when we look at the monthly data we saw, that was a record monthly increase in June. So there's a lot going on And that means laying off workers potentially. So. And then the other foggy is what's happening on the immigration front, the tightening of immigration and the increased deportation and restraining the inflows. What is that doing to the labor force and the employment numbers? So there's that fog of the tariffs and immigration because we're having huge seismic policy on both of those fronts. So a lot to think through. I would say that. And we were talking about the discouraged workers. I also think that may be also capturing how tough it is. If you are in immigrant, it may be it's even undocumented. You may be being picked up in that discouraged worker count as well. And you're dropping out of the labor force because you said, oh, boy, I can't get what I can't get a job.
Not that weak, yet not that strong either 00:08:58:11
When you look at the details, while the overall headline number looks solid and it may get someone like Fed Governor Wall will just say, you know what, maybe July is not on the table. And I do think that's the case. I think the any of the Fed officials that were leaning towards a July report, they've probably moved that off. But when you when you pull, you know, peel back the onion, you see that of the 47,000, 80,000 of those jobs were created in state and local government, not the private sector government. And within that, about 63,000 was in education. June is a tricky month for the Bureau of Labor Statistics. They tried to seasonally adjust the teachers roll off the payroll or public schools, but also colleges and how to account for that?
Job growth underpinned by noncyclical hiring 00:10:14:22
And then within that a very large share was in health care and social assistance. Now that's not bad, that it's good to have those jobs created, but those are <less cyclical> sectors and they tend to add jobs typically even when things aren't great in the economy. So typical sectors, everything else private. When we look at this private, typical employment is essentially been flat for several months… That gets back to employers just holding in the reins and not knowing what to do. But I think that's going to be so tough for the Fed or people, people like you who got to look at the economy and tell us where it's going is you know that there's uncertainty. You know, if I'm running a company, maybe I say, look, I won't lay people off, but I'm not going to hire anybody.
Wait and See…leads to wait and do less…as tariffs impede Powell 00:11:37:23
And I suppose in a way, that's why it's easiest is to say, let's wait and see. It's very difficult. It really is. And to, you know, to decide, okay, now we're going to possibly cut interest rates to maybe support an economy. It looks like it's softening again, lots of uncertainty. Is it really happening to the degree it's happening at a time also when inflation may start to pick up? …tariffs are, you know, at the heart, a negative supply shock. So some way they have to feed through to the economy. They either feed through to higher inflation and that could slow things down or less employment, less production. And that's sort of what the Fed has to weigh. And the inflation part, you say, well, that's temporary. The other thing that's layered in top on top of this is Fed Chair Powell was asked, well, at the global central Bank conference this week, and he said he would have lowered interest rates by now if it wasn't for the tariffs.
Fed retains its dovish cast 00:12:56:06
So that's interesting because what they're saying is policy is slightly restrictive. We knew that going into this year and <that> they would have, all else equal, without the tariffs cut interest rates. So, I think they're still have a dovish leaning and they feel policy still is restrictive, and would like to get <rates> lower, but they don't want to make a mistake and see inflation become more persistent than temporary.
Dealing with the dual mandate: markets look for rate cuts 00:14:07:20
I think Chair Powell did a really great job illustrating this: you've got to look at your two mandates, which are employment and inflation and how far current economic conditions are deviating from the goals you have for both. So one is 2% inflation. The other one is maintaining full employment, which means keeping the unemployment rate roughly where it is now, 4.1, 4.2%. So and if you get any deviation from both of those, it's the magnitude and the perceived duration of that difference. It's not an easy task. It could come off looking unusual for the Fed to be cutting rates, but they have to weigh those. And of course, you know, there's always you know, the market's weighing in as well. Now the markets are pricing in two 25 basis point rate cuts at this point.
Rate cut optimism in the face of inflation risk 00:15:09:07
That could change. You know, before this morning's number, I think there was a 50, at least 50% odds, of a third rate cut. It's kind of that's the camp we're in because I think that the inflation pick-up, we're going to get is largely temporary. The one caveat would add to it, which complicates things, is that there's still this risk of sectoral tariffs coming out, more tariffs, and the more they keep getting rolled in, if they come in later, <the pressures will be> persistent, then the inflation shock <magnifies> a little more.
Mixed/contradictory signals 00:16:11:16
Then on the other hand, we also saw a decline in hours-worked. You know, even if the jobs grew and even if you're paying people more money, if they're working less, that is a sign either of increased caution or, less demand. And you have these competing somewhat contradictory signals here, too.
Job slowing means income slowing and spending slowing 00:17:07:10
With that decrease in the hours, that detracts from the income for the for the consumer. And I think right now you see the consumer slowing. The second quarter is lining up to be softer for the consumer than we thought. We're looking probably -at most- at a contribution to GDP growth of about 1% for real consumer spending we thought maybe could be double that. You're seeing the payback of consumers pulling forward their spending ahead of the tariffs. But I think it may be more than that. I think if you look at the Conference Board, you mentioned that earlier, their consumer confidence survey, people are saying it's harder to get a job and they're worried about their income prospects. So even though sentiment and confidence have recovered a little bit from the really dire numbers, there's still a lot of reticence for consumers.
Fed to cut rates despite inflation risk because unemployment rises 00:18:32:08
So <our three rate cut prediction> is based on our view of the economy slowing; to GDP growth slowing to below 1%, and the unemployment rate actually picking up to 4.7. So embedded in that are some soft employment numbers that we're expecting in the coming months.
The Fed may be dealing with misses of both its mandates 00:18:57:10
For us, the odds of a third rate cut… we see strong odds of a third rate cut. But I would say that that it's a legitimate debate on how much the Fed is going to feel comfortable doing in the face of what we think will also be some acceleration of inflation. But we don't have inflation going to 4%. It's somewhere, you know, probably peaks out somewhere in the mid 3% at most.
Worst outcome would be Fed losing credibility 00:20:21:15
I think the worst thing for the Fed would be to lose credibility and for the markets to start to price in higher inflation for a longer period of time.
That hasn't happened. I mean, consumers are worried like if you look at the University of Michigan Consumer Sentiment Conference Board, those inflation expectations are still high, especially for that for the next year. They've come down a bit, but they're still high. But if you look at the Treasury market, so the so-called TIPS market, which is a Treasury inflation-protected securities, if you back out what the market's sort of estimating for inflation, it's very it's been very stable.
Various possibilities for inflation modification 00:20:50:08
So the market is saying these are saying two things, right. They're either saying there won't be much tariff price future or if there is, the Fed is going to do the right thing and make sure that this doesn't become a persistent problem. Or maybe the other view could be, there's other offsetting factors. Rental inflation falls, other, you know, other things that offset the increase in goods. And as part of that, maybe also people will just dampen their spending because they see price increases or pullback. That in itself anchors inflation lower over time. Even the Bureau of Labor Statistics has talked about this now. But this economy is different now in a lot of ways.
Required Job growth to keep unemployment steady has dropped 00:22:10:23
…it's certainly could be lower than 100,000, you know, somewhere between 50 and 100,000, maybe 75,000. But in that general area, one, because we have, you know, demographic change in America, right? The baby boomers are continuing to retire and so they fall out of the labor force. And we're having restrictions on immigration. That restricts labor supply and the availability of workers. To keep the unemployment rate steady, you need less employment, frankly, because the pool of available workers, either they're retiring or they're not able to enter as they normally would.
Firms have some flexibility at first to deal with tariffs 00:24:01:14
How do they handle that? And do they need to make other offsets? We think if enough gets passed through that it would push inflation up and accelerate it towards, three and a half, 3.4% or so year on year. And we just think there <could be> a delayed impact. Some of it's because inventories were built up. So, companies like in the auto industry, don't need to pass on the pricing. They can wait and see. And they're also playing a game of chicken, like, okay, let's see what our competitors do. And they want to make sure the consumer can handle it. But I think as the inventories get depleted and as more of that, the full impact of the tariffs are taken on, we're going to see some price increases.
If the Fed skips July, it’s harder to get three-rate cuts 00:25:35:21
I think I think two 25 basis point rate cuts or a 50… and two cuts is very high odds. We think that we have high enough odds, more than 50% chance we'll get another rate cut on top of that; it could be 25, 25, 25 could also be 25 and 50. I mean it all depends on how things play out. And, you know, we think about Chairman Powell again, what he said is we would have been cutting rates if it wasn't for the tariffs. So that's interesting.
Kathy Bostjancic
Kathy Bostjancic is Senior Vice President and Chief Economist for Nationwide Mutual. Kathy leads a team of economic analysts delivering economic forecasts and analyses that are used to inform and strengthen the organization’s business strategies and operating plans.
Prior to joining Nationwide, Kathy served as chief U.S. economist at Oxford Economics where she was responsible for assessing and forecasting the U.S. macroeconomic environment including Federal Reserve’s monetary policy, and its impact on industries and financial markets. Kathy served in similar roles at The Conference Board, Merrill Lynch, Union Bank of Switzerland (UBS), and Citicorp Investment Bank where she provided analyses on both U.S. and global macroeconomic topics, including international capital and foreign exchange markets, housing markets, U.S. consumer research, and global inflation and labor markets.
Kathy is a noted economic expert who holds a master’s degree in economics from New York University and a bachelor’s in economics from Rutgers University. She is a is a frequent speaker to media and industry groups on the economic outlook, monetary policy, macroeconomics and financial markets.
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