Labor Pain: The Hidden Cost of Tariffs

With tariffs rising and job growth collapsing, the Fed faces an impossible decision.

 

 

KEY TAKEAWAYS

• The Fed has a dual mandate: control inflation and maintain employment—both are in conflict right now
• Friday's jobs report showed major weakness—only 73k jobs added, with over 250k downward revisions
• Inflation, especially in durable goods, is starting to pick up again due to new tariffs
• The labor market no longer looks strong enough to justify the Fed’s "higher for longer" policy
• Fed Funds futures now show up to three cuts by year-end, with the first expected in September

MY HOT TAKES

• The Fed may have waited too long to act—and now it’s cornered
• Tariffs are stealth inflation machines, and they’re just getting started
• Labor market cracks are finally visible to everyone–not just economists
• Rate cuts are coming–but they’re arriving in an environment that still has inflation
• The Phillips Curve might be broken–but the Fed still acts like it isn’t
• You can quote me: “Powell probably spit his chamomile tea on the Washington Post when he saw that jobs number on CNBC.”

 

Jobs hatchet. The Fed has just two mandates: keep employment healthy and keep inflation in check. Just two. Imagine if your job were as simple. Simple, yes, but possible… maybe not so much. You see, theoretically, you can’t have a strong jobs market (low unemployment) and low inflation. The inverse relationship between the two was captured by economist A.W. Phillips in 1958. The curve, named rather uncreatively, The Phillips Curve, has become a central bank mainstay ever since. It has been modified slightly, but it still limits success in one by failure in the other. 

 

You don’t need me to remind you that inflation has been a real problem these past few years. The first wave–and deadliest to date–was the inflation resulting from the pandemic and the massive stimulus that followed. The Fed, which helped stimulate that inflation, sprung into action to eradicate it, switching its tool from fire to water. That water, unfortunately, likely erased a good portion of your hard-earned savings 2022. But a new hope emerged in the following year as inflation began to ebb and head back toward the Fed’s self-made target. The Fed would turn a soft cheek and markets liked it–a recovery began for equities. Soon, the Fed would back its good will with tangible rate cuts. Markets loved that too.

 

A new president would be elected. One which supported lowering regulatory barriers for business and who was committed to tax cuts. Of course, it’s more complicated, but at a high level, Trump’s promises were stimulative. The markets really loved that! The President was inaugurated, and no sooner did he mount up behind the Resolute Desk in the Oval Office, then he reminded us ALL about that other stuff he promised in his campaign. Massive tariffs.

 

Tariffs, depending on how they are described, can be a good thing or a bad thing. Most economists–this one included–believe that tariffs are bad and that they cause inflation as well as pain for domestic importers (which is just about every company in your portfolio). The President proved very quickly that he was not joking. It took a minute, but as of Friday, pretty much imports from anywhere in the world are being taxed by at least 15% with very few exceptions.

 

This puts the Fed in a very untenable position. For my international readers, we have an idiomatic expression for that: “the Fed is in a bit of a pickle.” How can the central bankers lower interest rates if inflation caused by tariffs is on the horizon? If the Fed is so sure that inflation is on the horizon, why doesn’t it just RAISE rates to head it off? Remember the Phillips Curve. High rates -> low inflation -> high unemployment. You know the other ½ of its simple job description.

 

The fact is that there is room for manipulation by the Fed. You see, the feedback mechanism between unemployment and low inflation is not fast. One can lower inflation by raising rates, and when joblessness increases, eventually, the Fed can simply cut rates to prevent a meltdown in the economy. More recently, the Fed has kept interest rates higher for longer in order to prevent tariff-born inflation. It has been able to justify this move by citing a strong labor market. I can’t remember a single Fed press conference in the past year in which a Fed official said something like “unemployment is near historical lows.” And it is, but will that last forever? Have a quick look at the following chart and let’s discuss.

 

 

This is a chart of New Nonfarm Payroll monthly additions. I am hoping that you can clearly see the downward trend in new monthly hires. This chart starts right after all those pandemic losses began to come back. You can see how jobs were being added at 500k clips up until 2022 when the trend began to decline. This is the result of saturation and, of course, aggressive Fed tightening. The trend continues to decline through 2024 where monthly additions were in the 100 to 200k range. But have a look at the right-hand side–2025 to date. That, folks, is a pretty stark decline toward 0. What? You don’t have a PhD in economics, mathematics, or statistics? That’s ok, recognizing that trend does not require an advanced degree.

 

This is where things get even more complicated. You see, Friday’s release from the Bureau of Labor Statistics–perhaps one of the top 3 monthly economic releases–missed economists’ estimates of 104k and came in at 73k. Now, there is an unwritten heuristic that below 100k is not good. I didn’t make it up–you can Google around for it. So, a 73k print is not considered to be too good. But, it gets even worse. June’s reported 147k jobs was revised down to 14k–not a typo. And May’s was revised down from 144k to 19k. That is a paper loss of 258k jobs in one fell swoop. Oh, and remember that heuristic? That leaves us with three prints below 100k. Those are not exactly the hallmarks of a “healthy” labor market, sorry. 

 

So, now what is the Fed to do? First, it is important to note that the Fed gets the same data that you and I get. They rely heavily on Government agencies such as BLS for its raw data. It is therefore, quite possible that Chairman Powell spit his chamomile tea on his Washington Post Friday morning after watching the release on CNBC. I would bet that he sure wished that he didn’t use the strong labor market as an excuse to keep rates higher for longer. Let’s not even get into the fact that he claimed that these rates are not restrictive.

 

So, maybe the labor market is not so strong after all. No problem, the Fed can just cut rates when the FOMC meets in September. But, wait, inflation has picked up a bit. Earlier in the week the PCE Price Index showed a nontrivial increase in Durable Goods inflation–not off the charts–just nontrivial. Can that be the canary in the coalmine? Is inflation finally showing up to the party after months of existing tariffs and a boatload of new ones starting later this week? Is hiring slowing significantly as companies adjust to this new tariff regime? Will it get worse? Will companies start increasing layoffs as the tariffs begin to bite?

 

If you think that the Fed was under pressure before, things got a whole lot hotter in the Fed’s HQ on Friday. Also, on Friday, we learned that Fed Governor Adriana Kugler was resigning early (her term is up in January). Kugler was one of the more hawkish FOMC members, and her departure may provide the President with an opportunity to nominate a more dovish one to take her seat. After last week’s 2 dissensions, a fresh dove would bring that to 3, which is ¼ of the voting membership. 

 

The next FOMC vote comes on September 15th. It is important to note that aside from Bowman and Waller–the dissenters–there are still doves Goolsbee, Cook, Jefferson, Barr, in addition to presumably dovish new person. That brings the vote to 7–a majority, even without Chairman Powell. Would those other doves rise and cut rates? Well, if they are using employment as a guide, the chances should be higher after Friday’s release. Fed Funds futures put chances of a September cut at 90%, a 66% chance of a second cut in October, and 100% chance of a second by December… and still another 48% of a third by then. High level, those chances went from 1 to almost 3 by December in one session. 

 

The Fed is in a really difficult position where it must weigh the importance of inflation fighting against the health of the labor market. If the Fed chooses to hold its ground and keep its foot on the brakes, the chances for recession will surely increase. Recession is certainly the most foolproof way to fight inflation, and if the Fed picks that path, it would certainly not be the first time. After Friday’s release, the Atlanta Fed’s GDP Now Forecast ticked down ever so slightly, shaving off -15 basis points of growth, but certainly not into recession zone. Kalshi betting markets upped the probability for a recession by the end of the year to16% from 10%. While we are there, 70% of Kalshi betters expect a 25 basis-point cut in September.

 

The Fed’s job, you see, is not so simple. It is now faced with the task of dealing with rising chances for unemployment while simultaneously dealing with high inflation. Wait, doesn’t the Phillips Curve suggest that as being impossible? It does, and it was also criticized for being wrong during 1980s stagflation. Enjoy what’s left of your summer, FOMC members, it's going to be a rough autumn.

 

FRIDAY’S MARKETS

Stocks sold off on Friday, capping off a tough week, after the administration slammed the world with tariffs the night before and the monthly employment numbers showed up rather sickly. Bets that the Fed will lower rates before the end of the year increased but it wasn’t enough to console the markets.

 

NEXT UP

• Factor Orders (June) may have declined by -4.8% after jumping by 8.2% in the prior month. Remember, these are challenging times for manufacturers, who are all trying to stay ahead of the wave of expected tariffs.
• This is a light release week for economic numbers, but last week will continue to resonate. We still have many important earnings releases, however. Download the attached calendars so you can be first in line to be in the know.
• Important earnings today: IDEXX Labs, Wayfair, Freshpet, Bruker, ON Semiconductor, ONEOK, Coterra, Vertex Pharma, Axon, Williams Cos, BioMarin, Hims & Hers, and Palantir.

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