White room economics: Stark market reality
September 23, 2025
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2 min
September 2025 highlights
Strange Brew: While inflation data is revealing some effects from tariffs on consumer prices, to date, that impulse has largely shown up simply as a deviation from the pre-tariff deflationary trend for core goods prices. Beyond those fingerprints, the magnitude of the impulse has been smaller than feared, suggesting some other economic actor is shouldering the burden. But with import prices largely unchanged and the dollar weaker, consumer prices remaining well behaved, and PPI suggesting margin compression, it seems as though corporates may be absorbing tariffs. But they’ll stomach that compression for only so long until they search for ways to claw back those higher costs.
Passing the Time: Markets have certainly grown more optimistic on the inflation backdrop given the smaller-than-feared impact on prices. While it is indeed possible that we’ve overestimated the impact, two other explanations may be to blame. Firms either are finding it difficult to push prices against a backdrop of slowing nominal growth or simply waiting to increase prices until they burn through low-cost pre-tariff inventory. And given an effective tariff rate remains well below the announced statutory rate, we may have further pass-through in store in the months to come.
Born Under a Bad Sign: With inflation prints remaining fairly well behaved, it’s no wonder the market’s focus has shifted rapidly to the labor side of the Fed’s dual mandate. Indeed, the consensus is well aware of the softening in labor market data of late, but that consensus seems to believe this cooling remains fairly benign in nature. As opposed to last year’s cooling, this year is about weakening labor demand, and signs that the linear cooling to date may morph into a more pernicious nonlinear deterioration continue to mount.
Badge: Payrolls growth has downshifted notably this year as cyclical momentum has cooled markedly. Jobs growth is now almost entirely a function of gains in the acyclical sectors of education and healthcare, as excluding those sectors, the economy has created just 69K jobs. While jobs growth has moderated in the sector, hours worked has plummeted to its lowest level on record. If hours are falling, there’s no need to maintain, let alone add to employment in the sector, suggesting labor markets may be on the verge of losing the last bastion of meaningful job creation.
Crossroads: As the balance of risks has flipped rapidly to the labor side of the dual mandate, the market has once again sharply repriced the policy rate outlook. The market implied terminal rate now sits just blow 3% as the market has priced in six cuts by the end of 2026. While the Fed resumed its easing cycle at the September meeting, the path of future cuts remains very much data dependent, as the Fed’s reaction function is far more reactive than it was at this time last year. With the FOMC bifurcated between labor doves and inflation hawks, there’s scope for markets to be disappointed in the near term, but less cuts now likely translates to more cuts later as labor markets continue to soften.
