Fed Shifts Strategy Amid Jobs Slowdown and Inflation Uncertainty

The U.S. Federal Reserve is recalibrating its monetary policy framework and positioning itself to adjust interest rates in response to evolving economic conditions, as outlined in a speech by Federal Reserve Chair Jerome Powell at the 2025 Jackson Hole Economic Symposium. The Fed is currently navigating a dual challenge: rising risks to employment and moderate upside risks to inflation, with Powell emphasizing that the shifting balance of these risks may warrant a change in policy stance. While the central bank has traditionally prioritized price stability, its recent assessments suggest a growing concern for the labor market, which has shown signs of softening.

The U.S. labor market, though still near maximum employment, has experienced a significant slowdown in job creation. Payroll employment growth averaged only 35,000 per month in the past three months, a sharp decline from 168,000 per month in 2024. This slowdown, coupled with a modest rise in the unemployment rate to 4.2 percent, reflects a broader adjustment in both labor supply and demand driven by tighter immigration policies and structural shifts in the economy. Powell noted that while the labor market remains in balance, the slowing of both supply and demand dynamics has created a "curious" situation where downside risks to employment are rising. This has raised concerns about the potential for rapid increases in layoffs and unemployment should economic conditions deteriorate further.

Simultaneously, inflation remains a key concern. Year-over-year core PCE prices rose 2.9 percent in July, driven largely by increased pricing in goods and non-housing services. Powell acknowledged that higher tariffs are pushing up consumer prices, but he suggested a "reasonable base case" is that these effects will be short-lived and not lead to a sustained inflationary spiral. The Fed is closely monitoring wage-price dynamics, as rising prices could trigger wage demands from workers. However, with the labor market not particularly tight and facing increasing downside risks, such a scenario appears unlikely at present. Powell also highlighted the importance of maintaining well-anchored inflation expectations, noting that measures of longer-term expectations remain aligned with the Fed’s 2 percent target.

To address these evolving conditions, the Fed has revised its monetary policy framework. This marks the second such review since 2020 and aims to ensure the central bank's strategy is suitable across a broad range of economic conditions. One of the key changes involves moving away from the "flexible average inflation targeting" approach adopted in 2020, which allowed for intentional inflation overshoots to offset periods of below-target inflation. The Fed concluded that this strategy had become irrelevant following the post-pandemic surge in inflation, which was neither intentional nor moderate. Instead, the revised framework emphasizes a balanced approach to achieving the Fed’s dual mandate of maximum employment and stable prices, recognizing that these goals may not always align.

The revisions also address communication challenges that arose from the previous framework, particularly around the language of "shortfalls" in employment relative to maximum levels. The updated language clarifies that the Fed does not intend to ignore labor market tightness or forgo preemptive action when necessary. Instead, the revised statement more precisely states that employment may at times run above real-time assessments of maximum employment without creating risks to price stability. This approach allows for greater flexibility in responding to divergent economic conditions while maintaining transparency and accountability.

Looking ahead, the Fed is expected to proceed carefully in adjusting its policy stance. While the central bank has ruled out a preset course, Powell indicated that the "shifting balance of risks" may warrant adjustments, with the labor market risks being of particular concern. This nuanced approach reflects the Fed’s commitment to data-driven decision-making, with any moves on interest rates contingent on ongoing assessments of economic indicators. The next key decision is scheduled for mid-September, and market participants are closely watching for signals on whether the Fed will proceed with rate cuts.