If a tree fell in the woods, but the data said it didn’t, does it really mean anything?

In spite of what appeared to be relatively good data, many polls throughout the 2024 election cycle showed more than half of all voters rated the economy as “poor.” That left the Biden/Harris team often wondering why they couldn’t get credit for what official statistics said was a robust economy.

Now it looks like we know why.  The Labor Department estimated that it’s going to need to revise down the amount of payroll growth between April 2024 and March 2025 by a total of 911,000.  This doesn’t mean payrolls outright declined during that year-long period; what it means is that contrary to prior reports of 147,000 jobs per month, jobs only grew about 71,000 per month in the year ending March 2025.

To be clear, these annual revisions are relatively small compared to total jobs (about 0.6% of the 160 million total), and we have seen revisions this large before.  But this is the third year in a row of downward revisions, which is unusual outside of dramatic events like recessions.

What all of this suggests is that the economy was much weaker last year than previously thought.   At present, the official GDP reports say the economy grew 2.0% in the year ending in March.  But reducing job growth from 147,000 per month to 71,000 could mean a noticeable downward revision to real GDP growth when that annual revision is announced by the Commerce Department in late September.

Just as important is that now, after revisions, when we look back at the year ending in March 2025, government jobs plus government-dominated jobs in healthcare and social assistance made up more than 100% of all jobs created.  As it turns out, private sector jobs outside of these areas declined.  No wonder voters weren’t happy about the economy.

More importantly, from an economists’ point of view, it clears up an economic mystery.  After surging in the first two years of COVID, the M2 measure of the money supply declined from early 2022 through late 2023, and yet economic growth appeared to be unaffected.  No recession, no major slowdown.

But what if government statisticians missed the slowdown and are just now getting around to finding it?  Moreover, what if the economic effects of the decline in M2 were temporarily masked or hidden in 2024 by a combination of (1) an unprecedented surge in immigration and (2) a reckless increase in the budget deficit?

If so, the risk of a recession in the next year or so is likely higher than most investors believe.  In the past several months, immigration policy has been turned on its head, with a sudden shift from virtually open borders to what could be an immigration flow close to “net zero.”  Meanwhile, the Congressional Budget Office is hinting that this year’s budget deficit will be smaller than last year’s relative to GDP while DOGE cuts to bureaucrat jobs are reducing government employment.

Long term, we believe a smaller government will pay dividends, leading to greater private sector growth and more prosperity.  But, in the very short-term, less stimulus could lead to some economic headwinds as workers and businesses have to adapt to the new environment.

In turn, this also means the Federal Reserve is almost certainly going to cut rates on Wednesday – we think by a quarter percentage point – and will be inclined to cut rates further in the fourth quarter, likely by another half a point total.

Some investors will see this as a reason to tilt even more toward risky assets.  But we are more concerned about the downside risk these policy measures are designed to protect us from than the measures being taken themselves. If a firetruck shows up at a house, that’s not a reason for civilians to run into the building, even if the data appear to say there is no fire. 

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist

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Implications:   Inflation came in above expectations in August, with the Consumer Price Index increasing 0.4%, and the year-ago comparison climbing to 2.9%.  “Core” prices, which strip out food and energy, rose a consensus expected 0.3%, while the twelve-month core comparison stood pat at 3.1%.  Looking at the details of the report, the volatile energy and food categories led overall prices higher, with energy prices rebounding 0.7%.  Notably, airline fares contributed the most to core inflation in August, with prices for the category jumping 5.9% after a 4.0% increase in July. Those are the two largest monthly increases for the airline fare since mid-2022.  In the past year, the main driver of core inflation has been housing rents, which rose 0.4% in August.  Other core categories to increase were prices for used cars and trucks (+1.0%), motor vehicle repair (+2.4%), and apparel (+0.5%).  Meanwhile, the category for medical care dropped 0.2% in August, as both prices for prescription drugs (-0.2%) and nonprescription drugs (-0.9%) declined.  In other news this morning, initial jobless claims jumped 27,000 to 263,000: the highest level since 2021. Meanwhile continuing claims remained at 1.934 million. These figures are consistent with a job market that is barely treading water in September, although the Labor Day holiday may have affected the report. Given the softening labor market and slow growth in the M2 measure of the money supply, we believe it’s time for the Fed to begin reducing short-term rates slightly in the months ahead, but cautiously. We expect the Fed to cut rates by 25 bps at the meeting next week. Yes, inflation remains above the 2% target.  But tepid economic and job growth suggests monetary policy is tight and inflation will decline in the year ahead.

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On Tuesday, the Bureau of Labor Statistics (BLS) released the preliminary benchmark revision of payrolls for the year ending in March 2025. In this week’s “Three on Thursday,” we explore what happened and its implications for jobs. Curious about the results? Click the link below to find out more.

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Implications:  Producer prices surprised to the downside in August, declining 0.1% following an unusually large increase in July.  Among the typically volatile food and energy categories, energy prices declined 0.4% in August while food prices rose 0.1%.  Excluding these categories, “core” producer prices declined 0.1% in August, matching the headline reading, although these prices are up 2.8% versus a year ago.  While tomorrow’s report on consumer prices will likely hold more weight in the Fed’s decision-making process when they meet next week, it looks virtually certain that they will re-start rate cuts that have been on hold since the start of the year.  The Fed remains concerned that tariffs will push prices higher at some point, but the data haven’t matched their expectations. In the past six months, goods prices – which are most exposed to higher import costs – are up a very modest 0.5% at an annualized rate.  Services prices are up at a 1.4% annualized rate over the same time period, suggesting the downward trend in inflation remains in place.  As we noted in prior reports, tariffs can raise prices for tariffed items, but they leave less money for consumers left over for other goods and services. They shuffle the deckchairs on the inflation ship, not how high or low the ship sits in the water.  That’s up to the money supply, which is up only 1.7% since April 2022.  We believe monetary tightness will keep inflation relatively subdued and that there is room for modest rate cuts.  In other recent news, the Bureau of Labor Statistics released initial benchmark revisions to nonfarm payrolls for the twelve months ending March 2025, estimating that payrolls during this period grew 911,000 less than previously reported.  With these revisions, it is now estimated that the US economy added around 71,000 nonfarm jobs per month during the year ending March 2025, versus a prior estimate of 147,000.  Slower job growth during this timeframe is consistent with the drop in the M2 measure of the money supply from early 2022 through late 2023 and there may be even slower job growth in the year ahead due to the lags associated with a tighter monetary policy as well as the temporary effects of slower growth in the federal budget deficit.

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Over the past twenty years, in spite of incredible new technologies, US real GDP growth has averaged just 2.0% at an annual rate.  By contrast, in the twenty years prior to the most recent twenty – from the mid-1980s thru the mid-2000s – real GDP grew at a 3.2% annual rate.  Some slower growth is due to the aging and retirement of Boomers, but in our view, the real culprit is the expansion in the size of government.

Government spending surged in 2008 and during COVID.  At the same time the Federal Reserve held interest rates extremely low, M2 growth surged, immigration accelerated, and environmental regulation altered economic activity.  Economists in government and academia promised us this would boost growth and jobs, instead growth slowed.

But now policies are changing.  The Big Beautiful Bill avoided a tax hike in 2026 (and made current tax rates permanent), tariffs are heading higher, immigration has slowed significantly, and regulations are being reduced.  In the first half of this year, the economy grew at a 1.4% annual rate.  The Atlanta Fed GDP Now model currently projects a 3.0% growth rate in the third quarter.  If that forecast turns out to be accurate, the annualized growth rate for the first three quarters of this year would be 1.9%, in-line with the modest long-term 2.0% trend.

At the same time, Artificial Intelligence is taking off and even though estimates about how AI will impact productivity and growth are all over the map they all say it’s positive.

So, with all these cross currents, uncertainty is substantial and to say the economic data have been “quirky” lately would be an understatement.  Nonfarm payrolls were up only 22,000 in August and are up only 70,000 per month in the past seven months versus growth of 146,000 per month in the same seven months in 2024.  Trade patterns are extremely volatile, with real GDP down in Q1, but up in Q2 and Q3.

A sharp drop in immigration is likely a key factor behind slower job growth.  Meanwhile, government payrolls are down 97,000 in the past seven months, the biggest (non-Census related) seven-month drop in at least 35 years.  We view this a positive for long-term private sector growth, but also a drag on jobs in the short-term.

But even as job growth has slowed, much of the economy has been holding up quite well.  Through July, retail sales are up 4.1% versus the same period in 2024; sales of cars and light trucks have averaged a 16.3 million annual rate so far this year, versus a 15.5 million rate in the first eight months of 2024. Manufacturing output in the first seven months of this year is up 0.8% versus the same seven months in 2024.  That might not sound like much, but factory production is below where it was ten years ago, so any growth in this sector is good news.

Is some of this increase in manufacturing due to reshoring because of tariffs?  After all, that’s what tariffs are supposed to do.  But the stop-start nature of some of the tariffs, as well as uncertainty regarding whether the courts will eventually strike down the tariffs is likely an obstacle for many firms to build out this production in the US.  It’s tough to make large, long-term commitments with so much uncertainty.

The case now nearing the Supreme Court is a prime example, with the Kalshi prediction market tilting toward a Trump Administration loss.  This all has to do with questions about whether Congress has delegated authority over tariffs to the executive, or whether trade deficits, fentanyl and border security are “emergencies” which the executive must address.

But even if SCOTUS strikes down the tariffs by early next year, that’s not the last word.  President Trump would likely use other laws already on the books to try to impose tariffs, or could seek legislation to raise tariffs, possibly through budget reconciliation, which would require only a simple majority in the Senate.  In other words, uncertainty remains on this issue.

That leaves AI…clearly it changes things.  Is it like the railroad or cellphone which accelerated travel, communication and trade?  Or does it cannibalize activity in areas like search or coding?   Growth in certain tech jobs has already leveled off.  We are not Luddites and don’t expect mass unemployment from AI; but some will gain while others lose.  In the near term we do not see an economic boom from AI similar to what happened in the 1990s in the first internet boom.  Then, economic growth picked up quickly; so far, with AI, we are still waiting.  And whether growth picks up in the future is still dependent on whether or not Congress and the President can get spending under control.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist

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Implications:  Today’s labor market report was hotly anticipated following President Trump’s firing of the BLS head after July’s weak data and large downward revisions, and August data are likely to add to the drama. Nonfarm payrolls increased 22,000 in August, lagging the consensus expected 77,000.  Worse, payroll gains for prior months were revised down by 21,000, meaning the net gain was only 1,000.  Notably, June data now shows nonfarm payrolls dropped 13,000 following these revisions, the first decline since 2020.  While the White House is likely going to continue pointing the finger at political manipulation, new policies that strictly enforce immigration laws, as well as uncertainty around trade policy and tariffs are likely weighing-down the job numbers. We like to follow payrolls excluding three sectors: government, education & health services, and leisure & hospitality, all of which are heavily influenced by government spending and regulation (including COVID lockdowns and re-openings).  This measure of “core payrolls” declined 36,000 in August, the fourth straight monthly drop, and is down 143,000 versus four months ago. One piece of good news is that civilian employment, an alternative measure of jobs that includes small-business start-ups, rose 288,000 in August. However, the labor force grew an even faster 436,000, which pushed the unemployment rate up slightly to 4.3% in August.  Taken all together, while its clear the labor market is weakening, recent numbers are consistent with a slowing but still growing economy.  Stricter immigration enforcement is likely a major part of the story, with a shift from essentially open borders having a major impact on labor supply.  The household survey shows that the foreign-born population (age 16+) has dropped 1.9 million since January while foreign-born employment is down nearly 1.0 million.  At the same time, native-born employment has grown 1.9 million.  In other words, recent softness in the labor market could reflect fewer illegal immigrants while native-born (and, potentially, legal immigrants) increase jobs and hours worked.  On the inflation front, average hourly earnings rose 0.3% in August and are up 3.7% versus a year ago.  However, these earnings are up only 3.5% annualized in the past six months, which along with recent weak headline jobs numbers gives the Federal Reserve all the ammunition it needs to re-start rate cuts later this month.  Finally, the Trump Administration is making progress reducing federal payrolls, which when we exclude the Post Office and Census workers are down 85,000 versus January, the largest seven-month drop on record going back to at least 1990.  In time, we think a smaller government should pay dividends in the form of faster economic growth.

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For today’s “Three on Thursday,” we take a closer look at the global electric vehicle (EV) market—an industry growing at breakneck speed, but in ways that may surprise you. In 2024, worldwide EV unit sales topped 17 million, and in 2025 they’re on pace to exceed 20 million, meaning nearly one in four new cars sold this year will be electric. The story, however, looks very different depending on where you are. Click the link below to find out more.

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Implications:  The U.S. trade deficit widened in July to $78.3 billion, the largest in four months. Imports surged by $20.0 billion, far outpacing the modest $0.8 billion gain in exports. Much of the jump reflects companies once again trying to front-run “reciprocal” tariff rates expected to take effect for countries still lacking trade agreements with the U.S. This comes after three straight months of import declines, which followed the unprecedented Q1 surge as firms rushed to get goods in ahead of the April 2 tariffs. That earlier spike weighed heavily on economic growth in Q1—net exports alone shaved roughly five percentage points off the growth rate, dragging real GDP down at a 0.5% annualized pace. As imports rolled off in Q2, trade flipped into a tailwind, helping to lift GDP. Superficially, July’s rebound in the trade deficit suggests trade could again turn into a temporary drag on growth in Q3. However, the largest contributor to July’s import surge was nonmonetary gold, which the BEA treats differently in GDP accounting, so the impact on growth should be much smaller than the raw import numbers imply.  Meanwhile, the structure of U.S. trade continues to shift. China has slipped to third place among U.S. trading partners, behind Mexico and Canada, with imports from China down 19.0% year-to-date through July compared to 2024. On a more positive note, the U.S. remained a net exporter of petroleum products for the 41st consecutive month, as the dollar value of petroleum exports once again exceeded imports.  In other news this morning, initial jobless claims rose by 8,000 last week to 237,000, while continuing claims fell 4,000 to 1.940 million. Also, this morning, ADP reported private payrolls fell 54,000 in August, consistent with our forecast for an increase in nonfarm payrolls of 80,000 to be reported on Friday. In other recent news, cars and light trucks were sold at a 16.1 million annual rate in August, down 2.9% from July, but up 6.2% from a year ago.

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Implications:  The US service sector once again demonstrated its resilience in August, with the index beating expectations and rising to 52.0.  That is the highest level for the ISM Services index in six months, a turnaround from its recent downward trajectory.  Looking at the details, growth was broad-based, with twelve out of eighteen major service industries reporting growth versus four reporting contraction.  The category for new orders led the overall index higher, as it rose to a ten-month high at 56.0.  Meanwhile, business activity also contributed, with the index rising to a five-month high at 55.0.  Despite the jump in orders and activity, service companies remained defensive with their hiring efforts.  Employment continues to contract in the service sector, with the category ticking up to 46.5.  That makes five out of the last six months where the employment index has been below 50, signaling contraction.  Service companies – once hamstrung with difficulty finding qualified labor – have begun reducing their headcounts, with more than four times the industries (nine) reporting a decline in employment in August versus an increase (two).  Finally, the highest reading of any category was once again the prices index, which slipped to 69.2.  That is near the highest level since late 2022, but still far from the worst we saw during the COVID supply-chain disruptions, when the index reached the low 80s.  Though inflation pressures remain – the M2 measure of the money supply is barely up versus three years ago – which means we are likely to see lower inflation and growth in the year ahead.  As for the economy, it’s important to remember that Purchasing Manager’s surveys like the ISM Services index and its counterpart on the manufacturing sector often capture sentiment mixed in with actual activity.  Uncertainty from trade policy has been weighing on sentiment, but could be alleviated as more trade agreements are finalized.  However, monetary policy has been tight enough to reduce inflation toward the Federal Reserve’s 2.0% target and is probably still modestly tight today.  And a monetary policy tight enough to reduce inflation may also be tight enough to slow the ever-resilient US service sector.

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Implications:  Manufacturing activity remained soft in August but did not contract as rapidly as in July, with the index rising to 48.7. This makes six consecutive months that the ISM Manufacturing index has been below 50, continuing a pattern that stretched all of 2023 and 2024.  While many believed the downturn was over when the index briefly rose above 50 in January and February, the subsequent six months of weak readings suggest caution is warranted.  Looking at the details of the report, seven of the eighteen major industries reported growth in August, versus ten that reported contraction.  The good news is the new orders index drove the headline increase as it broke into expansion territory for the first time since January at 51.4.  Order books were weak heading into this year, and survey comments suggest the added business uncertainty from on-again/off-again tariffs has caused many customer orders to pause until stability returns.  In response, manufacturing companies have scaled back, with both production and employment contracting in August.  Notably, though the employment index rose slightly in August, it is contracting near the fastest pace excluding the COVID shutdown months since 2009, with more than six times the industries (thirteen) reporting lower employment in the month versus higher (two).  Perhaps the worst part of the report is that inflation pressures remain even while manufacturing stagnates.  The prices index declined to 63.7, which is high by historical standards, but below the recent high of 69.7 in June, and well below the post-COVID inflation levels.  We will be watching the M2 measure of the money supply closely (which has barely moved for three years) as a signal for if these pressures will turn inflationary.  In other news this morning, construction spending declined 0.1% in July, as drops in manufacturing and commercial projects were partially offset by an increase in homebuilding.

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