Stagnant US Labor Pool Represents Inflation Risk

With valuations and spreads having swiftly recovered from the dislocations of the "Liberation Day" tariff announcements, risk perception in the equity and bond markets appears to reflect an economy in equilibrium—or what John Williams, president of the New York Fed, has described as “equipoise.”¹  For a central banker, this state suggests a balanced labor market and target-level inflation. And while there is evidence of equipoise in the current environment, investing by this narrative disregards the high levels of risk—inflation risk, in particular—that we believe persists. 

In our view, the labor market is the epicenter of inflation risk due to a looming supply shock. While the rate of natural increase in the US population (that is, the difference between births and deaths) has been in decline for much of the twenty-first century, this trend has been more than partially offset by net immigration. Assuming the Trump administration maintains its aggressive approach to immigration—and this seems like a safe assumption given the significant increase in US Immigration and Customs Enforcement funding baked into the recent tax and spending bill—this source of labor is likely to contract dramatically.²  

Moreover, the labor market’s current equilibrium level is a tight one compared to past cycles. With financial conditions again accommodative and the accumulation of public debt unrelenting, corporate profits and profit margins have been biased higher, and historical data suggest that job openings are likely to follow suit. The introduction of more jobs into a stagnant labor pool is a potential spark for wage inflation.³