This is a particularly challenging time to try to develop and present a balanced view of the economic outlook and its implications for investors. This is partly due to dramatic changes in trade, immigration and fiscal policies that are just beginning to impact the economy, partly due to distortion and mismeasurement in many key economic series, and partly due to sharp attacks on the Federal Reserve and, more recently, even government statisticians, that can cloud the judgement of political partisans on both sides.
Beneath it all, however, we have the advantage of a very wide range of timely labor market statistics that, if pieced together, paint a relatively clear picture of the current state of the U.S. economy and the probable direction of growth, inflation and interest rates. These numbers suggest both slower economic growth and higher inflation in the months ahead, validating the Fed’s hesitancy to cut rates but calling into question both recent stock market gains and relatively low long-term interest rates.
The Slowdown in Labor Demand
One way to understand the current state of the labor market is to divide recent data into those numbers that primarily tell us about labor demand and those that inform us on labor supply.
On the demand side, the most widely-quoted number is non-farm payrolls which rose by just 73,000 in July, well short of the 110,000 consensus expectation. More importantly, revisions to May and June cut the cumulative job gain for those two months by 258,000, so that the average monthly job gain for the last three months is now just 35,000.
In this connection, in good conscience, I have to say that, while these downward revisions were larger than normal, there is no evidence that they were doctored for political purposes. Over the more than 30 years that I have analyzed government data, while there have been many times when I felt the numbers were distorted, I have never had a reason to question the personal integrity of the public servants compiling them – nor do I have any reason to do so today.
That being said, estimating the seasonally adjusted change in payroll employment is a tricky task for a few reasons. One reason is just that seasonal patterns are extreme, relative to normal underlying gains or losses in jobs. As an example of this, while seasonally adjusted payroll employment has risen in every single month since May 2020, in just this year so far, not-seasonally adjusted employment fell by 2.8 million in January, rose by an average of over 600,000 per month between February and June, and then fell by almost 1.1 million in July. With this degree of seasonality, even small changes in seasonal behavior in the wake of the pandemic, or a difference of a day or two in the timing of the survey week, can have a significant impact on seasonally-adjusted data. Another problem is that the response rate of companies to the payroll survey has fallen sharply in recent years, from well over 60% before the pandemic to less than 43% so far this year. Both of these issues deserve attention in improving the accuracy of the payroll survey.
Fortunately, we have plenty of independent checks on non-farm payroll data. Each month, ADP releases its own estimate of job growth, based on processing payrolls for more than 25 million private sector workers. While this is not particularly accurate in predicting the change in jobs for any one month, it should be better over longer periods. So far this year, ADP estimates that total private sector employment has grown by 84,000 per month, compared to 144,000 per month in 2024.
In addition, the total number of people employed, according to the household survey, while admittedly very volatile month-to-month, has fallen in four of the last six months. Other data on labor demand look more stable, although well down from their post-pandemic peaks. These include job openings, as measured by both the Bureau of Labor Statistics and the National Federation of Independent Business (NFIB) and the NFIB series on employer job-creation plans.
The recent slowdown in economic growth also points to the likelihood of less hiring. While overall GDP growth has been very volatile in recent quarters, due to swings in international trade and inventories, real domestic final demand has clearly decelerated, falling from 3.7% annualized growth in the third quarter of last year to 3.0% in the fourth, 1.5% in the first quarter of this year and 1.1% in the second. Economic growth tends to lead job growth by one to three quarters, so we believe this trend should imply a downshift in the growth in demand for workers both now and in the months ahead.
The Slowdown in Labor Supply
There is also, clearly, a lack of labor supply.
Part of this is due to the aging of the baby boom. According to Census projections released in 2023, if net immigration were zero, the population aged 18 to 64 would actually fall by over 300,000 people, or 0.2%, in the year ending in July 2026, and continue to fall at roughly that pace through 2030.
The labor force participation rate, (that is, the percentage of the population aged 16 and over that is working or actively looking for a job), has also fallen, from 62.65% in July 2024 to 62.22% in July 2025 – reducing the workforce by almost 1.2 million people. Roughly half of this decline can be ascribed to the aging of more of the population into its retirement years. But importantly, over the past year, the labor force participation rate has also fallen among those aged 18-54.
This may well reflect changes in immigration rules. As noted by our colleagues in JPMorgan’s Investment Bank in a recent note1, two very large programs, which have given almost 1.8 million immigrants from troubled countries the temporary right to live and work in the United States, are being phased out this year. Assuming that 70% of these people were in the labor force, this change in status could reduce labor supply by over 1 million workers. Moreover, as this phaseout occurs, many immigrants appear to be leaving the labor force. In July, while the labor force participation rate was down by 0.3% from a year earlier for native-born workers, it was down 1.2% for foreign-born workers.
It should also be stressed that all of the data in the household survey are based on population projections that are likely too strong. Following a severe undercount of immigration in recent years, the Bureau of Labor Statistics boosted its estimates of population at the start of this year and projected growth in the 16+ population that has averaged over 180,000 per month since February. This is likely much too high given the virtual elimination of illegal immigration through the southern border, gradually rising deportations and a declining issuance of immigrant visas at foreign embassies.
All of this suggests that the labor market is not just seeing slowing growth in demand but also a sharp squeeze on supply. Additional evidence of this can be seen in relatively low initial unemployment claims numbers and surveys showing that, while consumers still find jobs to be “plentiful” rather than “hard to get”, small businesses see significant problems with the quality and availability of job applicants.
Labor Supply and the Fed’s Dilemma
On September 9th, the Bureau of Labor Statistics will release an estimate of its annual benchmark revision to payroll employment, based on the quarterly census of employment and wages, or QCEW. While these adjustments will be based on the March QCEW, data from the December QCEW suggest that payroll employment growth in the year ended March 2025, which currently stands at 1.758 million, could be revised down by a number similar to the 818,000 downward revision seen last year. In addition to this, federal government employment should fall more sharply in October as the 76,000 federal workers who took buyouts in the spring, fall off government employment rolls.
All of this, combined with the dampening effect of tariffs on economic activity, should result in some weak months for job growth in the second half of 2025.
However, because of the weakness in labor supply, this may not result in a significant rise in the unemployment rate from the 4.2% seen in July. Moreover, wage growth, another sign of a tight labor market, could remain close to its current 3.9% year-over-year pace. In addition to this, we expect PCE inflation to climb to over 3.0% in the fourth quarter, due to tariffs, and to be sustained at that pace by temporary tax cuts in the OBBBA that should lead to a bumper crop of income tax refunds in early 2026.
And therein lies the Fed’s dilemma.
Tariff inflation is probably temporary, as was argued last week by Governors Bowman and Waller in explaining their dissent from the Fed’s no-cut decision. However, a sharp decline in labor supply, combined with expansionary fiscal policy, could sustain above-trend inflation well into 2026.
Since the start of this century, the U.S. economy has grown at an average annual pace of 2.1%, comprised of a 0.8% annual increase in the number of workers and a 1.3% gain in output per worker. Starting from a point of roughly full employment, given the continued retirement of the baby boom and considering the possibility that deportations and voluntary departures of immigrants entirely offset new immigration in the next few years, it is quite possible that the next five years will see no growth in workers at all.
If this transpires, the economy will grow more slowly but will only be capable of growing more slowly without igniting higher inflation. For the Federal Reserve, this implies that, despite urging from the administration, they should be very cautious in lowering interest rates. For investors, it suggests that they should no longer bet broadly on a strongly rising U.S. economic tide or lower interest rates but rather be careful to allocate to less frothy U.S. assets and diversify into alternative and international assets.