In an economy-revealing speech in late August at a conference in Jackson Hole, Wyoming, Federal Reserve Chair Kevin Warsh continued his campaign against being too precise in guiding the markets, saying, “We should not indulge a regime in which market participants are looking primarily to the Fed for their next trade.” At the same time, he was more precise than he had been at his press conference in July. Two comments from his speech provided the guidance. One was that recent inflation data “do not tell me that underlying trends have meaningfully improved.” The second was the observation that he would be “hard pressed to describe broad financial conditions as restrictive.”
Taken together, these comments point to an inclination to raise rates at the next Federal Open Market Committee (FOMC) meeting. Of course, the decision will be data-dependent, as it always is. The August employment and CPI data could change some minds at the FOMC, including Warsh’s. However, Warsh’s Jackson Hole speech suggests that the chances of a tightening at the FOMC’s next meeting on September 15 are now over 50%.
The decline in the unemployment rate in recent months supports this shift in thinking at the Federal Reserve. It has dropped from 4.5% in November to 4.1% in July. This tightening of labor market conditions has occurred despite very little job growth. Non-farm payrolls have grown by just 51,000 per month during this period.
The decline in the unemployment rate reflects the fact that the labor force is no longer growing. Since November, it has fallen by almost 2.5 million people due to the shift in immigration policy and an aging population. The labor force participation rate has fallen from 62.5% in November to 61.4% in July, an unusually large decline for such a short period. The combined effects of fewer immigrants and declining labor force participation explain why the unemployment rate has been falling even with very modest job growth. These developments suggest that the economy’s capacity for growth has downshifted and that the Fed needs to be alert to possible inflationary pressures from the labor market even in the absence of strong job growth.
Stagnant employment economy stats could inflate wages
Interestingly, the labor force participation rate for prime-age workers—those between 25 and 54—has fallen only slightly since November. This indicates that the larger decline in the overall labor force participation rate is a function of the aging population.
So far, wage inflation has not turned up. However, the members of the Federal Open Market Committee seem to have concluded that it would be too risky to wait until that starts to happen. Their assessment is influenced by the fact that inflation has been running in excess of their 2% target for almost six years now. This increases the danger that they could lose credibility and inflation expectations might no longer be as well-anchored as they have been. These problems have yet to materialize but the FOMC seems to be determined to act in a pre-emptive manner to prevent this from happening.
The FOMC did not anticipate that labor markets would tighten as they have. Last June, its forecast called for a 4.5% unemployment rate by the end of 2026. It is now 4.1%.When surprises of this magnitude occur, an adjustment of policy is often warranted. Inflation has also been higher than they were projecting last June. Indeed, their inflation forecast for 2026 is now a full percentage point higher than their projections from June 2025. These developments help to explain why bond yields have risen sharply in recent weeks.
While Warsh has been somewhat opaque in his assessment of the economy and associated developments in financial markets, higher-than-expected inflation and lower-than-expected unemployment provide an almost textbook justification for tightening monetary policy.
