Fed Chair Tries to Set the Record Straight

by with No Comment 1si NewsEconomic Development
Submitted by Uric Dufrene, Ph.D., Sanders Chair in Business, Indiana University Southeast
 

Back in July, the new Fed Chair, Kevin Warsh, took a beating from the markets. In one of his first appearances as head of the Fed, markets interpreted Warsh as not willing to commit to fighting inflation. He suggested that rising yields on Treasury bonds were doing some of the Fed’s work for it. Warsh’s reluctance to provide guidance on rate increases caused a whiplash in equity and bond markets.

So last week, when Warsh and others gathered in Jackson Hole, Wyoming, for the annual gathering of Fed officials, what else would one expect him to say? He had to redeem himself, and that’s what he did. He was more explicit in the Fed’s commitment to fight inflation and provided guidance that the Fed would be focused on prices. The market reaction was not that severe, suggesting that markets had approved of the purported commitment to price control.

Since that July meeting, yields on both the 10-year and 30-year Treasury bonds have remained elevated. The 10-year yield is around 4.7%, while the 30-year is above 5%. This means higher interest costs for the U.S. government and higher borrowing costs for consumers. Interest on the debt is now the third-largest item in the federal budget, behind only Social Security and Medicare, and is higher than the entire defense budget. Mortgage rates are about where they were in late July, averaging about 6.7%. The goal of Treasury Secretary Scott Bessent to bring long-term Treasury yields down is not moving in the right direction.

It will all depend on the next round of inflation readings. Both the CPI and the preferred Fed indicator, the PCE Price Index, remain above the Fed’s preferred 2% target. However, in the last three months, the CPI puts an annual rate of inflation of less than 2%. And while the labor market remains “strong,” it is showing some signs of renewed weakness. The combination puts the Fed in a tough spot. When it is all said and done, the weaker labor market, if national payrolls continue to undershoot, will take priority over inflation.

A look back shows that payroll growth was even lower in 2025. Preliminary payroll revisions were released last week, and the BLS reported that job growth for most of 2025 and early 2026 was weaker by 79,000 jobs. Had it not been for an increase of government jobs by 99,000, the picture would have been even worse. Private sector payrolls were 178,000 lower than originally reported. That means the previously stated average of 23,000 per month was even less than that.

There continues to be an emerging bright spot in the national economy, and that is manufacturing. This should come as a boon to Indiana and Kentucky. It took more than a year to work through the tariff mess, and that is one of the reasons manufacturing continues to see some pickup. Unfortunately, the latest tariff battle with Canada is not going to help, especially for states with significant trade with the country’s northern neighbor.

Odds are now pointing to a possible hike by the Fed in September. More than likely, the Fed will not move, keeping rates at the current level. Another weak labor report and CPI reports showing a meaningful decline in inflation may even bring about a cut before year end.

Why the Fed Is Moving Closer to a Rate Cut

by with No Comment 1si NewsEconomic Development
Submitted by Uric Dufrene, Ph.D., Sanders Chair in Business, Indiana University Southeast
 

— Despite Growing Talk of a Rate Increase

There’s been a lot of debate about whether the Fed should cut or increase interest rates. The year started with expectations that the Fed would need to cut rates several times throughout the year. Then the Iran conflict kicked off in February, causing a resumption of higher prices, especially at the gas pump.

A resurging Consumer Price Index (CPI) then shifted the discussion to why the Fed might need to increase interest rates, with several Fed officials voicing their support for rate increases. At the most recent Fed meeting, there were three dissents against the decision to leave rates unchanged, with all three supporting a rate increase.

In my last column, I suggested that the Fed should in fact hold, but that there was a chance we could see a cut by the end of this year. Based on some of the recent economic data, we are moving closer to that happening.

The last employment report showed the economy lost 23,000 jobs in July. This was a big miss, with economists expecting a sizable increase in payrolls. Even worse, May and June payroll numbers were revised downward by a combined 103,000 jobs, putting both months at an average of only 41,000 jobs.

The year started out with stronger payroll gains, with gains in three out of the first four months exceeding the payroll gain of any month in 2025. Since then, job growth has been less than impressive.

Not only have payrolls been sluggish, employment from the household survey has also been moving in the wrong direction. Employment fell in July by 87,000 and is down by around 1 million from last year. That means about 1 million fewer workers are employed than a year ago.

Part of this is due to a shrinking labor force. The nation’s labor force is down about 1.4 million from last year, and the participation rate, the percentage of the working-age population either employed or looking for work, is down almost a full percentage point from last year.

Fewer workers available makes it more difficult to create jobs. You can’t create a job if there is no worker to fill the position! A declining labor force will push employers to rely more on capital instead of labor, boosting things like productivity and profitability, both positives for the economy.

Our Mid-Year Economic Outlook back in May expected regional payrolls, particularly Louisville Metro, to pick up. This was largely due to the signals we saw in manufacturing. There was at least one positive in the last jobs report, and that was in manufacturing.

Manufacturing added 5,000 jobs across the nation. While this is not a large number, manufacturing is finally seeing a turnaround from the dismal growth of the last few years. Manufacturing payrolls are beginning to pick up, and this will come as good news for states like Indiana and Kentucky. We are not going to see massive gains in manufacturing jobs, but the region should see a pickup in employment due to activity in manufacturing.

The other reason the Fed is likely to hold at its September meeting, setting itself up for a possible cut later this year, is on the inflation front. Inflation is on the downward slope again. Prices are not declining, but the rate of change is getting smaller. Over the past three months, the headline CPI has increased by only about 0.2%. Annualized, that puts the recent pace of inflation at less than 1%. And we get the same result if we remove the cost of food and energy.

If we continue to see weak payroll growth, as we have over the past couple of months, along with continued improvement on the inflation front, the argument for keeping interest rates elevated will become increasingly difficult to make. Another weak jobs report could be enough to move the Fed from holding rates steady to cutting them before the end of the year.

From Tariffs to Tensions: Why Interest Rates Keep Changing

by with No Comment 1si NewsEconomic Development
Submitted by Uric Dufrene, Ph.D., Sanders Chair in Business, Indiana University Southeast
 

One of the beneficiaries of last year’s labor market weakness was a decline in the 10-year Treasury yield. When the economy begins to weaken, investors often shift toward the safety of U.S. Treasury securities. As demand for Treasuries rises, their prices increase and yields decline. Because the 10-year Treasury yield heavily influences mortgage rates and many consumer loans, lower Treasury yields are often followed by lower borrowing costs for households.

At the beginning of 2025, the 10-year Treasury yield had climbed to nearly 4.8%. Investors were pricing in stronger economic growth driven by expectations of deregulation and a more business-friendly policy environment. Thirty-year mortgage rates approached 7%.

Then came Liberation Day on April 2. By that point, the 10-year yield had fallen to roughly 4.0%. However, uncertainty surrounding tariffs and their potential inflationary effects quickly reversed that trend. By July 2025, the 10-year yield had climbed back toward 4.5%.

That uncertainty eventually showed up in the labor market. Hiring slowed dramatically as businesses delayed investment and expansion decisions. By year-end, 2025 had become one of the weakest years for job creation in more than two decades outside of a recession. As labor market conditions softened, the 10-year Treasury yield declined once again, falling back to around 4.0%, and mortgage rates followed. By March 2026, the average 30-year mortgage rate had eased to around 6.2%.

The conflict with Iran, which began in early 2026, quickly altered the outlook. Energy prices moved higher, pushing the Consumer Price Index upward to 4.2%. As inflation expectations increased, the 10-year Treasury yield rose to approximately 4.5% by June, while 30-year mortgage rates increased to about 6.6%.

Markets briefly received some relief following the ceasefire agreement. Treasury yields eased modestly to roughly 4.4%, and mortgage rates declined to approximately 6.4%.

More recently, renewed tensions and the breakdown of the ceasefire have pushed oil prices back toward the $100-per-barrel range. Treasury yields and mortgage rates have reversed course once again, with the 10-year Treasury yield now hitting 4.7% and 30-year mortgage rates climbing back to roughly 6.7%.

The latest inflation report, however, offered some encouraging news. Headline CPI fell 0.4% on a month-over-month basis, largely reflecting the sharp decline in energy prices following the ceasefire memorandum of understanding. The improvement was not limited to energy. Core inflation, which excludes food and energy prices, was flat for the month, while the year-over-year core CPI rate declined from 2.9% to 2.6%.

These shifting conditions have changed expectations for Federal Reserve policy. While some market participants have discussed the possibility of another rate increase, such a move appears unlikely at this point. The first half of 2026 produced stronger hiring than the exceptionally weak pace seen in 2025, but the most recent employment report was disappointing. Job growth came in well below expectations, while both employment and labor force participation declined. One month does not establish a trend, but renewed uncertainty surrounding tariffs could once again weigh on business investment and hiring.

The most recent Fed meeting was a hold, but the bond market reacted quite negatively as perceptions of Fed Chair Warsh’s commitment to fighting inflation worsened.

It is also worth noting that much of the economy’s recent strength has been concentrated in a few areas. Without continued investment in artificial intelligence and steady hiring in healthcare, overall GDP growth would have been considerably weaker, and the national conversation might be centered on job losses rather than job gains. 2nd quarter GDP out last week showed the economy softened.

Despite recent geopolitical developments and surge in bond yields, financial markets continue to expect inflation to remain relatively well contained over the longer run. Five-year market-based inflation expectations remain near 2.3%. Assuming geopolitical tensions ease and energy prices stabilize, inflation should continue moving lower, providing the Federal Reserve with additional room to leave interest rates unchanged this year. Continued masking of the economy behind AI and healthcare might even provide the Fed with ammunition for a 4th quarter cut.

What Indiana’s Fastest-Growing Counties Have in Common

by with No Comment 1si NewsEconomic Development
Submitted by Uric Dufrene, Ph.D., Sanders Chair in Business, Indiana University Southeast
 

One of the simplest measures of whether a community is succeeding is whether people choose to live there. Population growth reflects thousands of individual decisions about where families want to build their lives and where businesses see opportunity. Although no single statistic tells the entire story of a local economy, population growth often captures the cumulative effect of many factors that make a community attractive. This week, we compare Indiana’s twenty fastest-growing counties over the past five years with its twenty slowest-growing counties to see how they differ across several important economic indicators. Clark and Floyd Counties are among the fastest-growing counties in the state, and both appear in the fastest-growing group.

One of the primary benefits of population growth is a growing labor force. Businesses can only expand if workers are available, and regions can only attract new employers if they can meet workforce needs. Not surprisingly, we see stark differences between the fastest and slowest-growing counties in both job growth and business formation.

In the twenty slowest-growing counties, employment increased by just over 8,000 jobs, representing a 4% increase over the five-year period. The number of business establishments grew by only 334, or 3%. Average weekly wages increased by more than $163, an 18% gain.

By comparison, the twenty fastest-growing counties added more than 173,000 jobs, a 9% increase. Not a big surprise because the fastest growing counties in Indiana are also the largest, but the growth on a percentage basis is more than double. The number of establishments expanded by 13,237, representing a 14% increase. Average weekly wages rose by $196, also an 18% increase.

One factor behind stronger population growth is in-migration. The twenty fastest-growing counties gained more than 18,000 residents through domestic migration over the five-year period, while the twenty slowest-growing counties barely surpassed 1,000. Much of that migration occurred in the years immediately following COVID, when remote and flexible work arrangements allowed more people to relocate. The source of that migration is also revealing. Cook County, Illinois, was the largest contributor of new residents to the fastest-growing counties. For the slowest-growing counties, Marion County was the largest feeder, followed by Daviess County, likely reflecting moves to neighboring counties.

Educational attainment also differs substantially between the two groups. In the fastest-growing counties, bachelor’s and graduate degree attainment exceed the Indiana average and closely mirror national averages. In the slowest-growing counties, both measures fall below state and national averages.

The industrial composition of these counties also tells an interesting story. The slowest-growing counties are less economically diversified, with just three industries accounting for 46% of total employment. In the fastest-growing counties, the top three industries account for only 38% of total employment, reflecting a broader mix of economic activity.

Manufacturing remains the largest industry in the slowest-growing counties, but average annual wages are approximately $28,000 lower than manufacturing wages in the fastest-growing counties, perhaps reflecting differences in educational attainment, technology adoption, and productivity. Healthcare is the largest industry in the fastest-growing counties, where average annual wages exceed those in the slowest-growing counties by nearly $16,000.

The differences become even more pronounced in knowledge-based industries such as professional and business services, finance and insurance, and information. Together, these sectors account for 16.4% of employment in the fastest-growing counties compared to just 8.9% in the slowest-growing counties. Salaries in these industries are also substantially higher, ranging from 21% to 47% above those found in the slowest-growing counties.

The counties experiencing the strongest growth have built more diversified economies, attracted higher-skilled workers, and generated stronger business formation and higher wages. While every community has unique strengths and challenges, the data suggest that long-term prosperity depends on more than recruiting a single employer or industry. It requires building places that offer economic opportunity, quality jobs, educational attainment, and a quality of life that attracts and retains talent.

The lesson is clear: communities that invest in talent, economic diversification, and quality of place are also the communities that are best positioned for sustained population and economic growth. For areas that resist or combat population growth, in whatever form that might take, the result could be the opposite.

Labor Force May Be One of the National Economy’s Biggest Challenges

by with No Comment 1si NewsEconomic Development
Submitted by Uric Dufrene, Ph.D., Sanders Chair in Business, Indiana University Southeast
 

The first half of 2026 marked a noticeable improvement from the weak hiring that characterized much of last year. Throughout 2025, the national economy averaged fewer than 10,000 payroll jobs per month, making it one of the weakest years for job growth in more than two decades outside of an officially declared recession. This year, however, monthly payroll gains consistently exceeded 100,000 jobs.

That changed with the June employment report.

The June payroll release showed the U.S. economy added just 57,000 jobs, well below market expectations. Nearly all of the gains came from healthcare and education, which added 69,000 jobs. Private sector payrolls increased by only 49,000 jobs, underscoring the weakness in hiring across much of the economy.

Financial markets responded quickly. Government bond yields declined, and investors reduced the probability of additional Federal Reserve interest rate increases. If next month’s report shows similar weakness, expectations could begin shifting toward another Fed rate cut later this year.

The more concerning news, however, came from the household component of the survey.

The nation’s labor force fell by 720,000 workers, causing the labor force participation rate to decline from 61.8 percent to 61.5 percent. This was not simply a one-month anomaly. Since December 2025, the U.S. labor force has declined by approximately two million workers.

A shrinking labor force creates a significant headwind for future job growth. Businesses cannot hire workers who are not participating in the labor market. This occurred throughout 2025 with the slowdown in the labor force coinciding with weaker payroll growth. While the number of employed workers fell by more than 500,000 in June, the unemployment rate nevertheless declined one tenth of a percentage point to 4.2 percent because fewer people were actively participating in the labor force.

The picture is somewhat different here at home.

Unlike the national economy, the region’s labor force has begun to improve. After remaining essentially flat throughout 2025, labor force participation has strengthened during 2026, providing a positive signal for the regional economy. Employment has also increased compared with early 2025, helping reduce the unemployment rate from 3.9 percent in January 2025 to 3.2 percent in January 2026. The region continues to see strong in-migration numbers, resulting in a growing labor force.

Indiana as a whole tells a similar story. The state’s labor force has grown modestly over the past year, while employment growth has outpaced labor force growth. As a result, Indiana’s unemployment rate declined from 3.7 percent to 3.3 percent.

Looking ahead, labor force availability may become one of the most important factors determining the success of the nation’s reshoring efforts. Manufacturers cannot expand production without an adequate supply of workers. At the same time, I suspect much of the next wave of reshoring, if any, will rely less on adding workers and more on investments in robotics and automation. In many cases, manufacturers will resort to using capital over labor.

That should not necessarily be viewed as bad news. Greater automation increases productivity, improves profitability, and helps domestic manufacturers remain globally competitive. In an era of slower labor force growth and an aging workforce, higher productivity may prove to be the key that allows American manufacturing to continue expanding despite a more limited supply of workers.

From Manufacturing to Healthcare to Meta

by with No Comment 1si NewsEconomic Development
Submitted by Uric Dufrene, Ph.D., Sanders Chair in Business, Indiana University Southeast
 

Twenty years ago, Facebook was little more than a social networking site for college students. Today, the company, now known as Meta, is one of the world’s largest technology firms, a major player in artificial intelligence, and is building a data center right here in Southern Indiana.

Thinking about Meta and other AI companies such as OpenAI and Anthropic got me reflecting on just how much the Southern Indiana economy has changed over the past two decades. Twenty years ago, Southern Indiana’s corporate landscape looked very different. Names such as Pillsbury, Key Communications, Colgate, Hitachi and Jeffboat were prominent employers. Manufacturing was the region’s largest sector, representing roughly 20 percent of all jobs and exceeding healthcare employment by nearly 8,000!

Back in 2005, the average weekly wage in Southern Indiana (Clark, Floyd, Harrison, Scott, and Washington) was $601. Today, based on the fourth quarter of 2025, that figure stands at $1,106, an increase of 84 percent. That’s an average annual wage growth of 3.1 percent. Over the same period, inflation averaged approximately 2.5 percent per year.

In other words, wages in Southern Indiana have generally grown faster than the cost of living, resulting in meaningful gains in purchasing power and quality of life for many workers. The question is why. To answer it, we need to examine which industries grew, which declined, and how wages changed across sectors.

The largest increases in absolute average weekly wages occurred in finance and insurance, where wages grew at an annual rate of 3.5 percent, and real estate, where wages grew at an annual rate of 5.5 percent. While not every occupation in these sectors requires a college degree, many are knowledge intensive jobs that depend on specialized skills and professional expertise. Wage growth was impressive, although employment growth was relatively modest, with the sectors adding approximately 450 jobs over the twenty-year period.

Healthcare and social services, which include ambulatory health care, hospitals, nursing and residential care facilities, and social assistance, was the leading growth sector, adding approximately 8,000 jobs. This is as many as manufacturing, retail trade, transportation and warehousing, and accommodation and food services combined. Wage growth of 2.4 percent trailed both inflation and the regional average. Today, healthcare and social services have surpassed manufacturing as the region’s largest sector, employing roughly 2,000 more workers.

Transportation and warehousing, a cornerstone of the Southern Indiana and Greater Louisville economy, posted the second largest gain in employment, adding approximately 6,000 jobs. Average weekly wages increased by $441 during the period, translating into annual wage growth of 2.4 percent, slightly below the average rate of inflation.

Wholesale trade, another logistics related sector, also performed well. It added more than 1,100 jobs while recording annual wage growth of 3.7 percent, comfortably exceeding inflation.

One of the strongest performers was professional, scientific, and technical services. This knowledge-based sector includes engineers, consultants, computer professionals, architects, and other highly skilled occupations. Average weekly wages increased by $752, while employment grew by nearly 1,700 jobs. Annual wage growth averaged 3.5 percent, outpacing inflation by a full percentage point. Few sectors combined strong job growth and strong wage growth as effectively.

Turning to the production sectors, both construction and manufacturing experienced solid wage gains. Construction wages grew at an annual rate of 3.8 percent, while manufacturing wages increased by 3.4 percent annually. Construction added 544 jobs despite the severe impact of the housing collapse during the Great Recession.

Manufacturing presents a more nuanced picture. While the sector lost approximately 2,000 jobs over the twenty-year period, total wages paid in the sector increased by 76 percent and average weekly wages nearly doubled. This pattern is consistent with productivity gains that allow manufacturers to produce more output with fewer workers.

Another notable source of job growth was accommodation and food services. The explosion of restaurants, entertainment venues, and lodging options throughout Southern Indiana is evident in the data. The sector added nearly 4,000 jobs and posted annual wage growth of 3.9 percent. Although average wages remain well below the regional average, workers in the industry nevertheless experienced meaningful wage gains over time.

The strongest combination of wage growth and employment growth occurred in finance and insurance, real estate, professional and technical services, and wholesale trade. Some of these sectors tend to be knowledge intensive and skill driven, reflecting broader changes in the regional economy. The two industries that generated the most jobs, healthcare and social services and transportation and warehousing, saw wage growth that lagged both inflation and the regional average.

The Southern Indiana economy of 2026 is not the Southern Indiana economy of 2005. While manufacturing and logistics remain important pillars, the region has steadily added more knowledge based and professional occupations. Healthcare has replaced manufacturing as the region’s largest employment sector.

The arrival of companies such as Meta and the growth of artificial intelligence are reminders that economic change never stops. The jobs of the future may look very different from the jobs of the past, but the data suggest that regions able to attract and grow higher skilled industries are also the regions most likely to see rising wages and improving living standards.

As we look ahead, digital infrastructure will become increasingly important to economic competitiveness. Data centers are emerging as the highways, railroads, and industrial parks of the AI economy, providing the computing power needed to support the next generation of businesses and innovations. Regions with robust digital infrastructure, reliable power, and access to advanced computing resources will be better positioned to attract investment, support entrepreneurship, and compete for the jobs of the future.

Just as access to rivers, railroads, and interstate highways helped shape the Southern Indiana economy of the past, access to digital infrastructure may help shape the Southern Indiana economy of the future.

Looking Beyond the Headline: Encouraging Signs in Indiana’s Labor Market

by with No Comment 1si NewsEconomic Development
Submitted by Uric Dufrene, Ph.D., Sanders Chair in Business, Indiana University Southeast
 

The last 12 months would not be described as a robust labor market. Indiana has now recorded seven consecutive months of negative year-over-year job changes. Outside of an official recession, this is the longest streak of negative year-over-year declines since 2003. Negative year-over-year job losses typically coincide with a recession, but no recession has occurred, making this trend even more concerning for Indiana.

Despite the overall weakness in payroll growth, there have been some encouraging signs that mirror positive developments in the national labor market. Education and healthcare has been the leading sector supporting payrolls over the past year, with the latest data showing a gain of 8,000 jobs. This relationship is typical. When overall job growth weakens, healthcare is often the most resilient sector and continues to expand. During the past four recessions, overall payrolls declined while education and health care remained in positive territory.

One bright spot in the Indiana labor market is growth in professional and business services, which is up 5,000 jobs over the year. Growth in professional and business services is often associated with business expansion and increasing demand for highly skilled workers. This time last year, employment in the sector was down 3,000 jobs, and overall payroll growth subsequently contracted. As a result, growth among professional and business services workers, often referred to as knowledge workers, is an encouraging sign for the broader economy.

Retail employment is also up by 5,000 jobs over the year. Retail employment gains are further evidence of consumer resilience. Despite higher interest rates and elevated prices, households have continued to spend, supporting retail activity and broader economic growth.

The largest declines in private-sector employment have occurred in manufacturing, transportation and warehousing, and leisure and hospitality. However, the most significant year-over-year decline has been in government employment, which is down nearly 17,000 jobs from a year ago. In fact, if government employment had remained flat, Indiana would be reporting growth in overall payrolls.

As we move through 2026, payroll growth should become more broad-based, allowing Indiana to return to positive year-over-year job gains. There are, however, some storm clouds on the horizon in the form of higher interest rates. Elevated rates were a major factor behind the slowdown in manufacturing, and persistently high borrowing costs could restrain the recovery that is beginning to emerge.

One of the conclusions from my recent Mid-Year Economic Outlook was that payroll growth would begin to accelerate both regionally and nationally. The latest national employment report showed the U.S. economy added 172,000 jobs, well above market expectations. Equity markets responded with one of their sharpest declines of the year. Stronger job growth combined with stubborn inflation suggests interest rates may remain higher for longer.

Even so, I expect inflation to trend lower during the remainder of the year. Both the Consumer Price Index and the Federal Reserve’s preferred PCE Price Index continue to reflect inflationary pressures, but several factors should contribute to moderation. Lower energy prices would contribute to easing headline inflation. Core inflation should also ease as the supply side of the economy continues to improve.

Manufacturing indicators such as the ISM Index have strengthened, while durable goods orders, factory orders, and industrial production have all shown improvement. This should bode well for Indiana. Job openings are also beginning to trend higher as the labor market recovers from the turbulence of the past year.

Indiana’s labor market is not yet firing on all cylinders however, but the underlying trends are positive. The challenge for the remainder of the year will be whether inflation and interest rates allow that recovery to broaden across more sectors of the economy. The likely scenario is that Indiana should soon move beyond its period of negative year-over-year job changes as payroll growth accelerates during the second half of the year.

Changing Drivers of Growth in the U.S. Economy

by with No Comment 1si NewsEconomic Development
Submitted by Uric Dufrene, Ph.D., Sanders Chair in Business, Indiana University Southeast
 

The consumer has been the dominant force behind U.S. economic growth over the past several years. Despite high inflation and persistently weak consumer sentiment, households continued to spend, driving much of the nation’s growth as measured by gross domestic product (GDP).

Over the past eight quarters, real GDP growth averaged 2.23% per quarter. Consumer spending accounted for roughly 83% of that growth, well above its traditional share of the economy.

However, the latest GDP report suggests that some of the headwinds facing consumers, particularly higher gasoline prices and a slowing labor market, may finally be having an impact.

Preliminary estimates for the first quarter show a notable shift. The consumer’s contribution to GDP fell to approximately 54%, down sharply from the 83% average over the prior eight quarters. Goods spending weighed on overall growth, with recreational goods and vehicles having the largest negative impact, reducing GDP by 0.22 percentage points.

The U.S. economy is primarily driven by services, and it was services spending that continued to support overall consumption. Given the shift toward an experience-based economy following the COVID shock, one might expect spending on experiences to remain strong.

However, food services and accommodations, a reasonable proxy for the experience economy, also detracted from growth, shaving 0.14 percentage points from GDP. Instead, nearly half of all services spending growth came from health care. This is consistent with trends in the labor market, where health care has been responsible for a disproportionate share of recent job gains.

Taken together, the report points to a consumer that may be beginning to weaken. This matters because of the outsized role consumers have played in sustaining economic growth.

If the consumer is losing momentum, something else must take its place. Increasingly, that “something” is artificial intelligence.

Gross private domestic investment, the category that includes spending on equipment, software, and structures, accounted for nearly 75% of GDP growth in the first quarter. Investment in information processing equipment and software, much of it tied to artificial intelligence, drove nearly all of that growth. Residential investment, by contrast, reduced overall growth.

Net exports were the largest drag on GDP. The negative contribution from imports nearly doubled the positive contribution from exports. Notably, much of the information processing equipment fueling AI investment is imported, reinforcing this drag on growth.

A great deal is now riding on artificial intelligence. Equity markets are near all-time highs, driven in large part by technology firms making substantial AI investments. Expectations for productivity gains are high, with many anticipating that AI will help ease inflationary pressures and create room for the Federal Reserve to lower interest rates.

For the past several years, the economic engine has been the American consumer. Consumer spending will continue to represent almost 70% of the U.S. economy, but investment in artificial intelligence is covering for other developing weaknesses. An economy relying less on the consumer and more on capital investment, particularly in emerging technologies, raises important questions about the sustainability and balance of future growth. The consumer has long been the foundation of the U.S. economy, and we can expect that to remain. Replacing that foundation, even partially, is not without risk. With a labor market that has been propped up by healthcare hiring, and substantial growth now driven by AI investments, a good question might be about the sustainability and duration of both.

Why the Fed May Need to Act Sooner Than Expected

by with No Comment 1si NewsEconomic Development
Submitted by Uric Dufrene, Ph.D., Sanders Chair in Business, Indiana University Southeast
 

Inflation remains sticky, but a pathway to a rate cut is emerging

Financial markets are currently anticipating no interest rate cuts by the Federal Reserve this year. In fact, expectations have shifted dramatically, with markets now pricing in the next rate cut as late as June 2027, compared to expectations of three cuts at the beginning of this year.

While financial markets are not pricing in a cut until next year, the Fed should, and likely will, reduce rates this year.

The Federal Reserve operates under a Congressionally mandated dual mandate: to promote stable employment and low inflation. The current policy framework targets an inflation rate of 2%.

One of the challenges with the dual mandate is that these objectives can come into conflict. Strong employment growth, for example, can generate upward pressure on inflation, prompting the Fed to raise interest rates to slow the economy and bring inflation back toward its target.

Conversely, weak employment growth is often associated with lower inflation, typically during or near recessionary periods. In that case, the Fed will place greater emphasis on supporting employment.

In both scenarios, rate cuts are used to stimulate economic activity, while rate increases act as a brake to cool growth and inflation.

While the Fed remains focused on inflation, it is past time to shift greater emphasis toward the employment side of the mandate. Current labor market conditions justify a rate cut, not in June 2027, but sooner, potentially at one of the upcoming meetings.

Start with employment growth. Over 2025, job gains averaged just 15,000 per month, making it one of the weakest years of employment growth in more than two decades outside of recessionary periods. Importantly, much of that growth has been concentrated in health care. Excluding that sector, overall employment growth would be flat to negative, hardly indicative of a stable labor market.

Last month’s employment report came in stronger than expected, but the underlying details were less encouraging. Health care again accounted for a significant share of job gains, while the labor force participation rate declined and overall labor force growth softened.

Unemployment claims remain low, but hiring activity has slowed considerably. Employers are holding back. A rate cut would help stimulate demand and encourage firms to expand hiring.

On the inflation side, headline measures continue to run above the Fed’s 2% target. Recent increases in the Consumer Price Index (CPI) were influenced in part by higher energy prices, driven by geopolitical tensions and a temporary spike in oil prices.

The Fed, however, focuses more closely on core inflation, which excludes food and energy. Core CPI has been more subdued, rising 2.6% over the past year. On a monthly basis, recent increases suggest inflation is running closer to a 2.4% annualized pace, still above target, but moving in the right direction.

The Fed’s preferred measure, the Personal Consumption Expenditures (PCE) price index, remains somewhat elevated. Core PCE increased 0.4% last month and is running near 3% year-over-year. While still above target, there are reasons to expect moderation in the months ahead.

Concerns about stagflation, a combination of slower growth and persistent inflation, remain valid. However, with geopolitical pressures potentially easing and oil prices stabilizing, headline inflation should begin to move lower.

In this environment, the “stag” is likely to outweigh the “flation.” Slowing employment growth will push the Fed toward a more accommodative stance.

At the same time, gains in productivity, driven by technological investment and artificial intelligence, may help ease inflationary pressures, giving the Fed additional room to cut rates without reigniting inflation.

The Fed does not need to wait until 2027. The conditions for a rate cut are beginning to fall into place, and the window for action is opening sooner rather than later.

A Strong Jobs Report—With Some Important Caveats

by with No Comment 1si NewsEconomic Development
Submitted by Uric Dufrene, Ph.D., Sanders Chair in Business, Indiana University Southeast
 

Over the past couple of weeks, setting aside the recent stock market volatility, the incoming economic data have leaned positive. The main takeaway is that the Federal Reserve will likely push back any rate cuts that were previously expected.

The biggest positive surprise came from the monthly jobs report. The consensus forecast called for an increase of 60,000 jobs, but the economy added 178,000. Private sector job growth was even stronger, with 186,000 jobs added. The unemployment rate declined to 4.3%.

One sector that has been shedding jobs showed a modest pickup. Manufacturing added 15,000 jobs, another sign that the sector may be seeing some green shoots after a couple of years of contraction.

It was not all positive, however. The labor force participation rate declined by one-tenth of a percentage point, and the labor force itself shrank by nearly 400,000 workers. Payroll revisions for January and February showed 7,000 fewer jobs than previously estimated.

And, similar to recent trends, a large share of job growth continues to come from healthcare. That is not necessarily a negative, but it does highlight that job growth outside of healthcare has slowed considerably. Since 2024, job growth in all other sectors combined is down more than 300,000 jobs, while healthcare employment has increased by nearly 900,000. The broader economy’s job engine, outside of healthcare, remains stuck.

Job openings declined from the prior month but came in slightly above expectations. Hiring, however, dropped sharply, with hires falling significantly from January levels. Excluding the COVID shock, this marks the steepest decline in hiring since the series began in 2000. In fact, hiring did not fall as sharply during the Great Recession as it did in February of this year.

While February represents only one data point, the magnitude of the decline provides further evidence of what has been described as a “no hire–no fire” economy. The gap between unemployed workers and job openings has widened, suggesting that the job market is becoming more competitive for those seeking employment. At the same time, layoffs, as measured by weekly unemployment claims, remain at very low levels.

We have discussed signs of improvement in manufacturing in recent weeks, and those signals continue to emerge. The latest ISM (Institute for Supply Management) manufacturing report showed additional expansion in March, marking three consecutive months of growth. Both new orders and production increased, pointing to a more positive trajectory for the sector.

However, the ISM report also indicated continued contraction in manufacturing employment. While the March jobs report showed a gain in manufacturing jobs, Eye on the Economy does not expect a surge in manufacturing employment, even with potential reshoring as supply chains adjust to ongoing trade policy uncertainty. Moving production from lower-cost regions to higher-cost environments does not necessarily translate into increased payrolls. To remain globally competitive, manufacturers will likely rely more on capital investment and automation. This is positive for the U.S. economy, but not necessarily for employment growth in that sector.

Recent data move us further away from an imminent recession, but stagflation remains a risk. Inflation continues to prove sticky, and with energy prices on the rise, price pressures may persist.

The latest jobs report was encouraging and helped reverse some recent weakness in job growth. However, the gains are not broadly distributed across the economy. For many, a more competitive job market will feel like a recession, even if the data say otherwise. And for consumers, higher gas prices ensure they won’t need a data release to feel it.