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In this episode, macroeconomist Claudia Sahm discusses how US jobs, payroll and CPI releases for July 2026 point to structural rather than cyclical change in the labor market. With the Jackson Hole meetings coming up at the end of August, Dr. Sahm shares what the market needs to hear from Chair Kevin Warsh. Finally, we uncover the risk of fiscal dominance in the US and why bond markets should care.

Keywords

US economy, Federal Reserve, inflation, labor market, housing market, fiscal policy, monetary policy, Claudia Sahm, fiscal dominance

Timestamps

00:24 Recent US economic data and the Sahm Rule
01:01 Labor market analysis: structural changes and implications
02:10 Wage trends and inflation outlook
03:40 Inflation signals and Fed policy considerations
05:11 Housing market trends and regional differences
07:10 Housing market final analysis
08:10 Fed’s communication strategy and Jackson Hole expectations
12:20 Kevin Warsh’s vision and the Fed’s future direction
16:49 Fiscal policy, the US dollar, and international implications
20:37 The risks of fiscal dominance

Transcript

S. Aneeqa Aqeel (00:00)
Welcome to the HFR Podcast. I’m delighted to welcome back esteemed macroeconomist Claudia Sahm She’s a former Federal Reserve and White House economist, and now chief economist at New Century Advisors. Claudia has developed the Sahm Rule, a widely referenced business cycle indicator, and she provides expert analysis on all things Fed and macro across the financial news networks and in Congressional testimony.
Claudia, it’s great to have you with us.

Claudia Sahm (00:27)
Wonderful to be here. Thank you.

S. Aneeqa Aqeel (00:28)
So I want to jump right in. We got the jobs report last Friday, which was generally considered positive, but labor force participation also down. We got the CPI release this morning, which shows inflation at 3.4% year on year, core inflation at 2.5%. And the PCE release came out at the end of July, measuring inflation at 3.7%. How do you read the health of the US economy and the direction of movement based on these two reports and the Sahm rule?

Claudia Sahm (00:59)
So I would say overall fairly encouraging picture with the economy. I think it’s important to, you know, split it up into some pieces. So let’s start with the labor market. There we can say there’s a a lot of bounds in the labor market. especially if we’re thinking about the business cycle. Like I’m I’m not on recession watch. Job creation seems to be keeping pace with labor force growth. That’s what’s held the unemployment rate steady. It’s even ticked down some.

Now there was a lot of attention last Friday to the payroll numbers. So for July there was a small decline in net payrolls and there were down revisions in May and June. You know, really looking both under the hood, but also what we’ve seen for several months now is that very much is a reflection of the fact that labor force growth in the United States has slowed dramatically. Right.

And so I think right now what’s happening in the labor market, it’s structural. This is not cyclical. This is really about we have slowed down labor force growth. Some of that is by policy choice with a dramatic reduction in immigration, and some of it is demographics. We have an aging labor force. So that’s made it very difficult to kind of use,
“Oh, there’s a negative payroll. This is a sign; we could be going into a recession.” You can’t use those rules of thumb right now because labor force growth is so low that frankly we’re going to bounce around a little bit above zero, a little bit below zero. And then you’ve got to look in terms of payrolls, and then you have to look at the unemployment rate, which as I said has been stable, ticked down some. As you pointed out, some of what’s holding down the unemployment rate is we’ve had a drop in labor force participation. So that’s not a good reason for the unemployment rate to be lower, but it’s a structural reason.

Like we don’t have as many people looking for jobs. And the last piece in the labor market is you know looking at wages. And there’s a whole host of wage measures that the Fed tracks. The average hourly earnings is what we get in the employment report. And they’ve been moderating. Frankly, the July average hourly employment was kind of soft. But if you look at other measures, just in general, they’re either flat to slowing some. So like you look at this labor market, this is not an overheating labor market.

This is not a labor market that’s either creating inflation or is going to be the channel that inflation gets into and then spreads. Like that’s just not what this labor market looks like, but it’s relatively imbalanced, so it’s probably not one causing a lot of disinflation, and it’s probably not one that’s going to get the Fed off the sidelines to say be cutting rates to support it. It looks reasonably okay in an aggregate big picture sense, but with a lot of interesting structural things going on under the hood, right? So that’s on the on the labor market with inflation.

We now have had I think two months of inflation data, at least the CPI. We don’t have the full set for July yet, with like producer price index and PC, but the CPI today was encouraging in that it was another month that was a good CPI, right? We’re we’re getting the month over month pace of core up two-tenths of a percent. That’s pretty close to a, you know, if you annualize that, that’s getting close to what we’d want to see in terms of being on target. And so we’re getting, it’s like there was another piece of evidence in the a disinflation trend. Right. So, you know, which I think takes takes some of the likelihood of the Fed raising rates down today, but nothing is a done deal yet. They’re going to want to have all the data they can before September, which is another month of inflation and employment, but then also, I think they’re going to go down to the wire really debating what’s good enough given how long inflation has been elevated. So like I said, largely US economy, I think there’s a lot of encouraging signs, but there are still some problems. And and the big question is, are we really going to make that progress on inflation without the Fed doing more?

S. Aneeqa Aqeel (04:51)
Yeah. And I think adding to this picture is another key indicator, which of course is housing. we have, you know, single family housing sort of at a standstill, but we’ve got multifamily starts up in June, but permits are down. And then we’ve got high borrowing costs, which are also depressing, you know, builder confidence as well as household ability to buy. But at the same time, I remember reading last year how there were all these houses sitting on the market in Florida. And this year, inventory is actually falling in Florida, and it’s starting to begin to fall in Texas, which are two of the largest housing markets out there.

And then you’ve got the stock market and you’ve got the younger generation thinking hard about, you know, stocks being a better investment and a better way to grow their wealth and choosing to rent and not go towards home ownership. So what does that add to this picture and this analysis for the structural strength of the US economy?

Claudia Sahm (05:58)
Right. So in housing, there’s so many elements to pick up. I mean, there’s a very important geographic element. We’ve seen that since the pandemic, just patterns of mobility. Now we have some real patterns in, you know, reduced immigration or even out-migration. So different parts of the country look and and also housing supply is such a key piece of it. And in different parts of the country, it is easier or harder to increase that supply. And so there’s a lot of complexity to housing.

One place where it comes into the discussion, the overall economy, from the lens, the angle of the Fed, is, you know, another piece in addition to what’s happening with employment, what’s happening with inflation, is just getting a sense of like what is the Fed already doing in the economy? Right? With the federal funds rate where it is, how restrictive is it? And the place you go to see that is in the housing market. It is it is clear with mortgage rates having been elevated, and you know, we’re moving in the wrong direction this year, in particular, like it really does have an effect on affordability, in addition to the fact that house prices moved up quite dramatically after the pandemic and in a way that a balanced labor market with moderate wage growth just isn’t going to get people across the finish line. If they weren’t able to afford the housing, it’s getting further and further away from being possible.

So, you can look at the housing market, of the major sectors of the economy, it’s the one you’d point to with the most weakness. And it just in a in a business cycle sense, kind of the cyclical piece, and it has a lot of complexity with both the geography, the structural, you know, the echo effects of what happened since the pandemic. But it may there are some signs and you pointed to some different patterns in the data. It it is possible that it’s kind of hitting its bottom. And that we’re starting to see some signs in some parts of the housing market of things picking up. But but I’d say it’s really too early to kind of say that definitively.

S. Aneeqa Aqeel (08:01)
Okay, so let’s move on to the Fed and its shift in communication stance and its clarity.
In Kevin Warsh’s press conference last week, he seemed to hint that in January there could be a redefinition of how the Fed might measure inflation and indeed see its own role in shaping policy. What do you think he’ll say at Jackson Hole later this month? What would you like him to say? And what do you think would help calm the financial markets that
hold him accountable for his words?

Claudia Sahm (08:33)
The Feds meeting in July, especially the press conference, really kicked off a big debate about Kevin Warsh’s vision for the Fed, his leadership, his willingness to raise rates to fight inflation. I mean, there were just lots of questions that came out of that press conference. Some of it from was things he didn’t say. Like he hasn’t been very open, not just about where our rates are potentially headed, but even his reaction function, like his contingency plan. What would it take? Like he hasn’t said much about that. So there’s some question marks. And then as you point out, he said some things that gave people pause, like,
“What do you mean that PCE inflation might not be the target after January,” right? Kevin Warsh you know, he was a governor at the Federal Reserve. I was a staff economist when he was there. I remember Kevin from his time as a governor. He has, since the time he left the Fed, been very critical of the Fed. And I think he’s coming back as a Fed Chair, trying to be a transformative Fed Chair.

There could be some real upsides to that, right? It’s an institution; it’s a tough place to be innovative. I mean that comes a lot because they think really hard about what they do and there’s high quality standards, but that can sometimes stand in the way of creative thinking. So he does come in with some at least creative calls to action, but he has set a lot of variables in motion. And I think it’s a little overwhelming, I would imagine, for some of his fellow committee members, but it’s overwhelming externally too.

So there’s some things where I think he’s probably going to get a consensus behind him like, let’s do less forward guidance. Let’s not give so many signals about the next hike, you know, the next move is likely a hike or this or that. Like, I think that’s probably his least controversial view. A lot of people in central banking, not just in the US but globally, have said, you know, there’s a time and a place for forward guidance, but it’s a pretty narrow time and place. Let’s do that less. So maybe at Jackson Hole he comes in and he really gives the thinking behind that, gives us a full-throated with data, with evidence, like really like builds out his case. And I think then that’s one where people are going to be like, yeah, okay, that makes sense. Or if he, you know, isn’t going to do the reaction function, he’s really got to explain how that is helpful. Or just in Jackson Hole, what I what I would consider as you know, the first bar of like me being happy listening to the speech in Jackson Hole is just to understand his thinking better.

His mental models, his what data he looks at. I have a feeling it’s very different than my mental models, the things that I look at. I may not agree when I understand his thinking more, but he’s just too much of an enigma for the role he’s in. And I think it’ll help him build coalitions, build cooperation among the Fed and be that transformative Fed Chair. But you know, the feeling that he’s like hiding the ball and up at 30,000 feet and isn’t adding the details, it’s just, it’s kind of gotta stop, right? And I think he gets that. And Jackson Hole is the perfect setting for that. Right? It’s a symposium, the Fed goes away to the mountains and like they bring in academics, they’re thinking deep thoughts. Like this is the time for him to give a speech where he’s just putting his thinking out. It’s not tied to a policy decision. He’s not getting like peppered with journalist questions. He can just explain his thinking. If he does that, I think the reaction will be positive, but he hasn’t done that yet, so it’s really on him to bring it. And honestly, even as I’ve spent a lot of time listening to him, his prior speaking, his writing, like trying to think, I don’t know what he’s going to do. He really is something of a mystery.

S. Aneeqa Aqeel (12:20)
I guess yeah. And as a former Fed Economist yourself, the questions in my mind would be,
are the same staffers coming along with him that were working with him before? Is there any sense of that institutional memory that might help him in formulating his policy now. Is that something that would play into it?

Claudia Sahm (12:42)
Yeah, it’s a really interesting question that really only Kevin Warsh can answer and some of the staffers around him, I’m not there anymore. But one thing that had struck me, kind of thinking about his time as a governor, in 2010 he was opposed to QE2, so the second round of quantitative easing. And you know, reading the transcripts. And I wrote a blog post about that moment and time and kind of giving his word so people could get a sense of who he is.

And one of the things that he would push back on, you can hear him talk about this now too. He didn’t like the formality. Like you go into the FOMC meetings, the transcripts will be released five years later. And really since that’s become an established norm, people come in, they have prepared remarks, they read their remarks, they often have data, like there there’s a formality of it. And there’s some back and forth in discussion, but you know when he talks about he wants the good family fight and I think he’s seen that formality as like a barrier to new ideas.

And in 2010, he would try to do his arguments in a more like jokey, folksy kind of way. And that’s not going to play in that room because the credibility is so central to the Fed, to any central bank. And you have your ways, your norms of building that credibility, and there’s kind of this seriousness of purpose.

And so, I think he some of his tone, even at the press conference, it came across as him winging it or being too casual. And he’s an intelligent person. He knows this stuff. It’s kind of like misunderstanding why the Fed is the way it is. Like some of that seriousness, it really it has a purpose. And so, like, there’s a lot at the Fed that can be changed and improved and innovated, but it’s like you really need to know where those bright lines are because you don’t want to accidentally go over them.

Everyone I know who has worked with him in the past, the staff people who’ve worked with him speak really highly of the way he works with people, listens to people. So I I think he has it in him, it’s just there’s some right sizing that needs to happen, a little bit of course correction, not necessarily in some of his views, like no forward guidance. Again, I think he can have that. It’s just there’s some there’s some style that needs adjustment, but my goodness, he’s only done two meetings as a Fed Chair, right? And this is a job unlike any other. In an institution that is a very strange institution, I think for some many of them good reasons, not all good reasons, but so I I think he’ll get there. But it’s really going to be telling if he steps up to the mic in Jackson Hole and he’s serious and he kind of gets it, things are going to be on a good path. If he gets defensive or he keeps it, you know, with his like evasive jokey stuff, like I I don’t think it is going to be pretty.

S. Aneeqa Aqeel (15:36)
So speaking of the strangeness of the institution and the specific ways in which it interacts with the economy, my last question to you is the overlap between fiscal and monetary policy. So if I look at some of the themes that continue into this year from last year, there’s the implementation of the Genius Act, which has opened more doors for stablecoins, which essentially privatize payment systems, given the 100% backing requirement that the Treasury wants, and that coincides with the Treasury’s move to change the term structure of government borrowing, you know, tilting more towards short-term bills. Then we’ve had the hit that the US dollar has taken in its reserve currency status, arguably across the globe.
And now the US Treasury last week took this open and direct action in currency markets to support the Japanese yen and that too by selling Euro reserves. So I take all these things together and I wonder, does this pose a challenge to effective conduct of US monetary policy going forward? And what is the best way to manage the paradigm change here?

Claudia Sahm (16:49)
There are some real risks here. And it does it does tie into Kevin Warsh’s vision for the Fed and how he leads as a Fed Chair. One of the most disconcerting things that I’ve heard him say, and I think this came out in his confirmation hearings, was that you know the idea that the Fed needs a new Treasury Fed accord.

And that’s the in 1951, the agreement between the US Treasury and the Fed that the Fed would resume setting interest rates, its policy rate, on its own. Like during World War II, the Fed had kept interest rates low to help, you know, reduce the costs of the war effort. But in 1951, it was like, no, the Fed is going to do this so they can focus on, you know, inflation, right? As opposed to borrowing costs for the government low. So when Kevin Warsh says we need a new Treasury Fed accord, you’re like, whoa, what it’s what are we talking about here?

There’s a very benign interpretation of, you know, the reality is the Fed has a large balance sheet, the government has a large federal debt, and the Fed and Treasury need to be in close communication. And in crises times, there, you know, there are times for the Fed now to set up emergency lending facilities. They do have to have buy-in from the Treasury. That was part of the post-global financial crisis. And you could argue maybe communication should be better. So there’s a very benign version of a new Treasury Fed Accord.

There is a less benign version where you have a lot more coordination between the Treasury and the Fed, where the Treasury might actually be giving kind of marching orders to the Fed. You know the Treasury in helping support the yen was able to use tools that the Treasury itself had, but Secretary Bessent had pointed out, well if the Fed raised the cap on their facilities, then this could do even more. So it’s like the Treasury has tools to do interventions. The Fed’s got bigger tools, right? And so if you get in a place where we’re handing the keys over of the Fed’s balance sheet to the Treasury to say get interest rates low because they want to do more borrowing, that’s a real inflation risk. That’s not a history we want to repeat. And so I this this was exactly one of those cases where Warsh just like throws something out there that could mean a lot of different things, but there’s some real risk there.

And I think, you know, setting Warsh’s view aside, there’s a lot of messaging from the White House, from the Treasury, that has been kind of pushing at the Fed to do things. They’ve been much more open and I think much more creative about kind of putting pressure on the Fed. And so I mean a big overarching label for it would be fiscal dominance, right? So that the fiscal authority, White House, Treasury, they’re the ones kind of calling the shots on monetary policy.

And, you know, there’s a lot in the institution at the Fed that protects the Fed from having this happen. But I think the reality, the backdrop with the government debt as large as it is, I mean, the incentives are really there. So you know, as I said a risk. Not my base case, not where I think we’re headed. but there’s just been actions by Treasury that make me concerned that it could bleed over into the Fed. And some of Warsh’s messaging hasn’t been as clear as I’d want. I mean, honestly, like we’re turning the first few pages of the fiscal dominance book. Like we’re not far into it, but I think it’s a real risk and certainly should be a risk for anyone in bond markets. And I mean it could go in a very bad direction pretty quickly.

S. Aneeqa Aqeel (20:33)
All right. Well, I hate to leave it on that big question mark.

Claudia Sahm (20:37)
Sorry!

S. Aneeqa Aqeel (20:39)
But yeah, no, thank you. I really wanted to hear your views on that. So I really appreciate that and thank you for your time. You know it’s exactly two years to the day that you were here with us before. So thank you again, Claudia.

Claudia Sahm (20:52)
Wow. Thank you.

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