Monthly Economic Outlook –July 2025

[00:00:00] Speaker 1: Welcome. I'm Nicole Servi and I'm joined here today by my colleague Charlie Dougherty for our latest Wells Fargo Monthly Economic Outlook. So Charlie, we've seen plenty of changes to economic policy in these recent weeks. So could you kick us off by telling us a little bit about how these policy changes are impacting the economy today and what we expect in these next few months here? [00:00:32] Speaker 2: Thanks, Nicole. So the economy seems like it's still in a pretty decent place. You know, we've had a lot of disruptions and distortions so far this year, mostly as a result of these shifts in trade policy. So an example of that is we've seen a lot of volatility in imports this year as consumers and businesses have tried to front-run tariffs. But if you kind of look at the core parts of the economy, namely consumer spending and business investment, they seem like they're growing at, you know, maybe a slower rate but at a pace that's still pretty solid. So I think the important thing to remember here is that we are expecting a moderation in the second half of this year. So you still have elevated levels of uncertainty. They've come down a little bit, but it's still a very uncertain economic environment. And that's very likely to be a headwind for business investment moving forward. Then you have a moderation happening in the consumer sector. So one thing that I think is worth pointing out is that we've seen a slowdown in consumer discretionary services spending, and we expect that moderation to continue. So overall what we have here is an economy that's still holding up, but it's slowing down. So Nicole, we have an economic slowdown happening on the horizon. How do you think the labor market will perform under those conditions? [00:02:02] Speaker 1: Yeah, so the labor market tends to be, and if you look at employment growth, the coincident indicator. So the way that you described economic activity via GDP growth is largely the similar trends that we're seeing in employment growth. We've seen a moderation, we've seen a slowdown, but not necessarily a complete collapse. If you look at nonfarm payrolls, for instance, in June, they actually rose stronger than expected, and the underlying pace of payroll growth is at pretty healthy levels. Same with the unemployment rate. It is historically low. But to your point, Charlie, we've gotten some evidence that consumer spending, particularly in these discretionary categories, is softening, and that's going to put some pressure on employers at the time where they're dealing and coping with higher input costs. And so, one of the valves that these firms can pull or release valves that firms have at their disposal is layoffs. And so we do think that you'll see an uptick in layoffs in the second half of the year, just as there's a softer sales environment and some firmer inflationary pressure. And what we look for in the second half of the year is for nonfarm payroll growth to decelerate to around 50,000 jobs added per month on average through the second half of the year. With employment growth slowing down to that degree, you will get some upward pressure on the unemployment rate. And we do look for the unemployment rate to peak at around 4.4% by the end of the year. That doesn't really sound like a very high level on the unemployment rate. But if you look at what's going on underneath the service, we have some slowing labor force growth, especially tied to thinning immigration flows, and that's actually going to keep kind of a ceiling on how far the unemployment rate can rise. And so for all intents and purposes, we do look for the labor market to gradually cool through the second half of the year and in pace with economic activity moderating. [00:04:02] Speaker 2: Yeah, so it sounds like we have a weaker labor market moving forward. What about inflation? How are inflation [00:04:09] Speaker 1: dynamics expected to play out? I'll dovetail it with the labor market. What you're seeing is as employment growth has slowed down, that has actually eased the pressure on firms to really hike their wages, right? If we look back a few years ago out of the pandemic when hiring was really aggressive, you had wage growth picking up aggressively as these employers were hiking their wages to attract and retain workers. More recently, we're seeing an unwinding of that. Employment cost growth is down, and so that's easing inflationary pressure. At the same time, with the softer sales environment, what we're seeing is that firms, they just don't have as much pricing power today as they did perhaps two years ago. And so that's going to keep a limit on how much of that tariff cost if firms can actually pass through to inflation. And so we do look for inflation to rise, especially for consumer prices by the end of the year, but we don't necessarily look for a spike. If you look at our core PCE deflator forecast, for instance, we look for that to peak at around 3.1% by the end of the year. That is still higher than where we are currently, but it's not necessarily a spike as we said previously. What we're seeing is as this muted demand backdrop is kind of taking form, that's going to restrain the magnitude in which inflation can rise. But we still are seeing higher unemployment, higher inflation by the end of the year. So, Charlie, let me turn it back to you. If we see unemployment rising, if we see inflation firming up, even on the margin, how does the Fed respond to this kind of stagflationary situation? [00:05:48] Speaker 2: We think the Fed is going to be on pause for the remainder of the summer as they sort of stay cautious on inflation. But you get to the second half of the year, and ultimately, I think the focus of attention starts to shift back towards this weaker labor market we're expecting and slower economic growth. So, right now, our forecast for the Fed funds rate is we're expecting three rate cuts this year, 25 basis points each, starting in September. And it's kind of interesting, if you look at the June FOMC meeting, they released their summary of economic projections. And their economic forecast is actually pretty similar to our own, meaning the Fed is expecting a slight increase in unemployment, a slight bump up in inflation caused by tariffs. And overall, they're still expecting to cut rates a few times this year. So overall, monetary policy is still restrictive, and that gives them enough room for to cut rates a little bit more if the economy weakens, as we're currently expecting. [00:07:01] Speaker 1: Well, good talking to you, Charlie. And from all of us at Wells Fargo, thank you for tuning in to our latest monthly economic outlook.