1 big thing: Cautious optimism on AI economics

Illustration of an briefcase filled with binary code

2. Japan isn't so primed for rate hikes after all

Today, we look at a fascinating new speech from a top Federal Reserve official gaming out the macroeconomic implications of artificial intelligence. That, plus the latest from Japan. 🇯🇵

Situational awareness: The Treasury Department announced the formation of an economic and financial working group with the Chinese government, meant to provide "ongoing structured channels for frank and substantive discussion on economic and financial policy matters."

It continues the Biden administration's efforts to establish clearer communication with Beijing despite large substantive divides.

Today's newsletter, edited by Javier E. David and copy edited by Katie Lewis, is 654 words, a 2½-minute read.

Macro

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Stay ahead of the curve on the most important economic developments with reporting and analysis on how business, policy, and markets collide.

Axios Macro

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1 big thing: The risks from rising long-term rates

2. Powell's long-rates shrug

The ripple effects of the Fed's higher-for-longer message on interest rates last week keep filtering out in financial markets — and, we argue today, could start to pinch the economy much as last year's rate surge did.

Today's newsletter, edited by Kate Marino and copy edited by Katie Lewis, is 648 words, a 2½-minute read.

1 big thing: The logic to U.S. debt downgrades

2. The semantics of default

The Treasury Department building in Washington

The U.S. government's fiscal year ends Saturday, and a shutdown looms. Today, we have a special newsletter takeover by our colleague, Axios chief financial correspondent Felix Salmon, on the government's credit ratings.

Today's newsletter, edited by Kate Marino and copy edited by Katie Lewis, is 589 words, a 2-minute read.

Fed officials see way out of inflation woes without major economic pain

1 big thing: Superficially hawkish, structurally dovish

2. A divided Bank of England surprises

What a week for central bank nerds. Today, we unpack the real meaning of yesterday's Federal Reserve's communications and then look at some surprising decisions from its counterparts around the world.

Still on tap: The Bank of Japan, meeting Friday Tokyo time. 🇬🇧 🇨🇭 🇸🇪 🇳🇴 🇹🇷 🇯🇵

Situational awareness: Initial jobless claims came in surprisingly low, with only 201,000 Americans filing for benefits last week. That's down by 20,000 from the previous week, the latest evidence that the job market remains solid and layoffs few.

Today's newsletter, edited by Kate Marino and copy edited by Katie Lewis, is 716 words, a 3-minute read.

Where the job market is growing and shrinking in the U.S.

1 big thing: Where the job market is starting to crack

2. British inflation cools down

It's Fed day! Look for the latest Federal Open Market Committee policy statement at 2pm ET, accompanied by Fed officials' projections for growth, inflation and interest rates. Chair Jerome Powell takes questions from the media at 2:30; Neil will be in the room.

In today's Macro, we look at the state-by-state shifts in unemployment. Plus, new U.K. inflation intrigue. 🇬🇧

Today's newsletter, edited by Kate Marino and copy edited by Katie Lewis, is 620 words, a 2-minute read.

National

The central story in financial markets over the last couple of months has been a surge in longer-term interest rates, fueled by a growing consensus that elevated borrowing costs — at least compared to the 2010s — are here to stay.

Why it matters: The latest move higher in long-term rates is already hammering stock prices. Over time, it is likely to create new cracks in the economy as well.

By the numbers: The benchmark 10-year Treasury yield reached 4.52% this morning, a new 16-year high. It was 3.35% as recently as early May.

These long-term rates are not directly driven by the Fed's interest rate policy but rather by markets' expectations for how growth and inflation will evolve, how the Fed will react in the future and the supply of longer-term bonds from the U.S. government.

This particular run-up is mainly driven by a rise in real interest rates, not by higher investor expectations of inflation. It implies that investors increasingly think the Fed will have to keep its interest rate target high indefinitely to hold inflation down.

Between the lines: It takes time for the impact of higher long-term rates to filter through to the economy.

With the 30-year fixed mortgage rate well north of 7%, home sales and building activity could see another leg down. Already, a slowdown in residential investment has subtracted from GDP growth for nine straight quarters, with the steepest drags occurring in the second half of last year as an earlier spike in rates had its effects.

Some corporate debt rates have risen as well (though not nearly as much as Treasury yields have), which could make companies more reluctant to spend and invest in the coming months.

Of note: A new index created by Fed staff earlier this year aims to capture how much financial conditions are poised to slow or stimulate the economy. It emphasizes the levels of mortgage rates and corporate borrowing rates — not, as some other such indexes do, the spread between those rates and Treasuries.

In other words, the rise in rates seen in recent months would be expected to slow GDP.

The selloff in the stock market last week, alongside the renewed surge in yields, appears to be driven in part by a sense the Fed is unconcerned about the economic ramifications of high long-term rates.

State of play: Fed chair Jerome Powell was asked about the rise in bond yields at his news conference last week, and his answer seemed more like a shrug than an expression of alarm, which fueled the sense in markets that rates are likely to stay high.

Powell said that "they're moving up. It's not because of inflation."

"[I]t will probably have something to do with stronger growth, I would say more supply of Treasuries," he said. "You know, the common explanations that you hear in the markets kind of make sense."

That came after Fed officials released projections showing the consensus of policymakers is that they will keep their rate target above 5% throughout next year and that five officials believe that in the long run, rates will hover significantly higher than they did in the past.

Meanwhile, the central bank's "quantitative tightening" program continues apace, shrinking its balance sheet by up to $95 billion a month. That essentially lowers demand for longer-term bonds, a force helping drive their rates higher.

What they're saying: Market developments in recent days "underline our concern that the Fed erred in not putting enough weight on the big rise in longer-term yields," said Krishna Guha and Marco Casiraghi of Evercore ISI in a note.

They add that its communications are "being read in markets as inviting yields to surge still higher at a time when there is pressure from massive supply of debt … along with more structural shifts in the global economy."

Why rising long-term rates could ripple across the economy

It takes time for the impact of higher long-term rates to filter through to the economy.

Federal Reserve

Economy & Business

Is the rise of generative artificial intelligence an opportunity for turbocharged productivity and income growth, or a threat to millions of workers? The answer to both is effectively "yes," according to a top central banker who weighed in on the economics of AI on Friday.

Why it matters: It was the first time a top Fed official has spoken in detail on the macroeconomic implications of AI.

Driving the news: Fed governor Lisa Cook, speaking at a National Bureau of Economic Research conference in Toronto, said that "[e]conomic history suggests cautious optimism" in how the technology built on large language models might affect jobs.

What they're saying: Generative AI's economic importance depends on whether it turns out to be a "general purpose technology" that improves productivity across a wide array of industries, as tech advances and electrification did a century ago.

"The impact of AI on the economy and monetary policy will depend on whether AI is just another app or something more profound," Cook said. "The most consequential innovations in the past have been general purpose technologies that have broadly transformed the economy over an extended period of time."

She suggests there is a strong possibility this is the case. "Generative AI makes communication more efficient, and nearly all human activities—and all industries—involve communication," she said.

"It is true that if you let generative AI draft an email, write the minutes of a meeting, or research a topic, you will have to review, fact-check, and edit the result," she adds. "Nonetheless, thanks to AI's contribution, you may be much closer to your goal when you start than if you began with a blank page."

What's next: While that has the potential to make many jobs obsolete, the net benefits for workers and incomes should be favorable, Cook argued — though not without pain in some sectors.

"When the world switched from horse-drawn transport to motor vehicles, jobs for stable hands disappeared, but jobs for auto mechanics took their place," she said.

"New technologies may displace some types of labor, but they can also raise the productivity and incomes of jobs they create or complement," Cook adds.

"Nonetheless, the displacement effect might be concentrated and the productivity effect more diffuse. Therefore, while many workers throughout the economy benefit, a smaller set bear the brunt of the negative effects," which could make for "a difficult transition for some workers."

The bottom line: The potential — and pitfalls — for AI to shape the growth and jobs outlook is increasingly on the minds of top policymakers.

Go deeper: What AI means for growth, incomes and inflation

What AI means for growth, incomes and inflation

Top Fed official sees "cautious optimism" in economic impact of AI

It was the first time a top Fed official has spoken in detail on the macroeconomic implications of AI.

Artificial intelligence

Is the rise of generative artificial intelligence an opportunity for <a class="gtmContentClick" data-vars-link-text="turbocharged productivity" data-vars-click-url="https://link.axios.com/click/32800535.659173/aHR0cHM6Ly93d3cuYXhpb3MuY29tLzIwMjMvMDYvMTQvYWktcHJvZHVjdGl2aXR5LXJldm9sdXRpb24tYmFua3MtcmV0YWlsP3V0bV9zb3VyY2U9bmV3c2xldHRlciZ1dG1fbWVkaXVtPWVtYWlsJnV0bV9jYW1wYWlnbj1uZXdzbGV0dGVyX2F4aW9zbWFjcm8mc3RyZWFtPWJ1c2luZXNz/631f6fd43950fd001100f388B65b103b6" data-vars-content-id="5b39cd7a-3b18-4554-b5cc-a48b743a1baa" data-vars-headline="Top Fed official sees &quot;cautious optimism&quot; in economic impact of AI" data-vars-event-category="story" data-vars-sub-category="story" data-vars-item="in_content_link" href="https://link.axios.com/click/32800535.659173/aHR0cHM6Ly93d3cuYXhpb3MuY29tLzIwMjMvMDYvMTQvYWktcHJvZHVjdGl2aXR5LXJldm9sdXRpb24tYmFua3MtcmV0YWlsP3V0bV9zb3VyY2U9bmV3c2xldHRlciZ1dG1fbWVkaXVtPWVtYWlsJnV0bV9jYW1wYWlnbj1uZXdzbGV0dGVyX2F4aW9zbWFjcm8mc3RyZWFtPWJ1c2luZXNz/631f6fd43950fd001100f388B65b103b6" target="_blank">turbocharged productivity</a> and income growth, or a threat to <a class="gtmContentClick" data-vars-link-text="millions of workers" data-vars-click-url="https://link.axios.com/click/32800535.659173/aHR0cHM6Ly93d3cuYXhpb3MuY29tL2xvY2FsL2luZGlhbmFwb2xpcy8yMDIzLzA4LzI5L2pvYnMtbG9zdC1haT91dG1fc291cmNlPW5ld3NsZXR0ZXImdXRtX21lZGl1bT1lbWFpbCZ1dG1fY2FtcGFpZ249bmV3c2xldHRlcl9heGlvc21hY3JvJnN0cmVhbT1idXNpbmVzcw/631f6fd43950fd001100f388B3ce9299a" data-vars-content-id="5b39cd7a-3b18-4554-b5cc-a48b743a1baa" data-vars-headline="Top Fed official sees &quot;cautious optimism&quot; in economic impact of AI" data-vars-event-category="story" data-vars-sub-category="story" data-vars-item="in_content_link" href="https://link.axios.com/click/32800535.659173/aHR0cHM6Ly93d3cuYXhpb3MuY29tL2xvY2FsL2luZGlhbmFwb2xpcy8yMDIzLzA4LzI5L2pvYnMtbG9zdC1haT91dG1fc291cmNlPW5ld3NsZXR0ZXImdXRtX21lZGl1bT1lbWFpbCZ1dG1fY2FtcGFpZ249bmV3c2xldHRlcl9heGlvc21hY3JvJnN0cmVhbT1idXNpbmVzcw/631f6fd43950fd001100f388B3ce9299a" target="_blank">millions of workers</a>? The answer to both is effectively &quot;yes,&quot; according to a top central banker who weighed in on the economics of AI on Friday.Why it matters: It was the first time a top Fed official has spoken in detail on the macroeconomic implications of AI.

Data: Bureau of Labor Statistics; Graphic: Axios Visuals

In a country as large as the United States, there isn't just one labor market. There are many. And some are flashing more serious warning signs than others about the economy.

Why it matters: State-level jobs data released yesterday shows that while the U.S. job market remains on solid footing, a couple of states are displaying dynamics more commonly seen in recessions.

The good news is that those weaker job markets are relatively limited for now, with only four states and the District of Columbia seeing their jobless rate increase by more than half a percentage point over the last year.

The bad news is that some of the steepest rises were in highly populated California (up 0.8 percentage points) and New Jersey (up 1.2 points).

There were 18 states in which the jobless rate has fallen by half a percentage point or more in the last year, led by Maryland (down 1.7 percentage points) and Massachusetts (down 1.3 points).

The intrigue: As ZipRecruiter chief economist Julia Pollak notes, the recent unemployment swings in New Jersey, D.C. and California match those typically seen in recessions, according to a rule of thumb known as the Sahm Rule.

Invented by former Fed staffer Claudia Sahm, the rule is a handy real-time indicator of recession.

Her observation was that when the three-month national average of the jobless rate is more than 0.5 percentage points higher than the lowest unemployment rate over the last year, it's an almost foolproof sign that a recession is underway.

State unemployment rates tend to be more volatile than the national rate, reflecting smaller survey samples (and thus higher statistical error) and the natural volatility that can happen in states where employment is concentrated in a few industries.

So it's unsurprising that some states would trip the Sahm Rule even in a basically solid national economy. Still, localized economic problems can be an early warning sign of national ones.

What they're saying: "While some localized downturns remain contained, local trends can often expand to other regions or have downstream effects," Pollak tells Axios.

"Metros or states with the highest concentrations of a disrupted industry may be bellwethers that signal similar effects to follow in similar states, or lesser effects in other regions."

"Or they may highlight important trends that are hard to see in aggregate data due to offsetting effects in other regions, but that are nevertheless important for local populations," she said.

The overall U.S job market remains strong — but local pockets of weakness could be bellwethers for other regions.

Unemployment

In a country as large as the United States, there isn&#x27;t just one labor market. There are many. And some are flashing more serious warning signs than others about the economy.Why it matters: State-level jobs data released yesterday shows that while the U.S. job market remains on solid footing, a couple of states are displaying dynamics more commonly seen in recessions.

The most important takeaway from the Federal Reserve yesterday was this: Central bank leaders no longer believe there needs to be major economic pain to keep the economy on the pathway to low inflation.

Why it matters: Interest rates may well be higher for longer than seemed likely before the meeting — and bond markets have priced in exactly that over the last 22 hours. But Fed officials have backed away from their mindset that a significant slump is necessary to vanquish inflation.

The Fed's communications yesterday were "superficially more hawkish, structurally more dovish," as Skanda Amaranth of Employ America put it.

State of play: The superficially hawkish side came in the form of new projections that show 12 of 19 top Fed officials anticipate raising interest rates one more time this year, and a majority envision keeping rates above 5% throughout 2024.

That lowered market expectations that the Fed is done raising interest rates and will cut them significantly next year.

Yes, but: The structurally dovish tone came in economic projections. Fed officials now see the same glide path toward their 2% inflation target that they did in June, but see it coinciding with firmer growth and a healthier labor market.

In June, for example, the median official envisioned 1% growth this year and 1.1% next year, and the jobless rate rising to 4.5% by late next year. That, in the consensus forecast, was the cost of achieving disinflation.

Now, the median official sees 2.1% growth this year, 1.5% growth next year, and the jobless rate rising only to a mere 4.1% (it's currently 3.8%).

Between the lines: Fed leadership has gained confidence that the disinflation process can occur through channels other than mass job losses and a serious downturn in overall activity.

Supply chains keep healing, relieving some inflation pressure. Companies have cut back job openings, helping take the air out of the job market without widespread layoffs. More people have entered the labor force.

Meanwhile, 5.25 percentage points of rate hikes over the last 18 months haven't been enough to tank the economy. That implies the Fed may have more room to maneuver than it once seemed. It can raise rates again and keep them high in 2024 without being overly worried about going too far.

Conversely, it implies that if the economy does start to falter in a big way in 2024, the Fed will be more willing to toss its projections aside and cut rates in response, even if backward-looking inflation is still elevated.

The bottom line: "This is a Fed that sees an opening for a soft landing and will try not to blow it," said Krishna Guha and Marco Casiraghi of Evercore ISI in a note.

Call it "superficially hawkish, structurally dovish"

Fed chair Jerome Powell takes questions from the media. Photo: Chip Somodevilla/Getty Images

The most important takeaway from the Federal Reserve yesterday was this: Central bank leaders no longer believe there needs to be major economic pain to keep the economy on the pathway to low inflation.Why it matters: Interest rates may well be higher for longer than seemed likely before the meeting — and bond markets have priced in exactly that over the last 22 hours. But Fed officials have backed away from their mindset that a significant slump is necessary to vanquish inflation.

The Federal Reserve elected to leave interest rates unchanged Wednesday, and issued new projections indicating most officials anticipate one more interest rate hike this year.

Why it matters: The central bank's 18-month campaign to slow inflation sent convulsions through financial markets and put economists on high alert for a recession. That campaign now appears to be coming to a close, though rate cuts appear far off.

Details: The Fed's policy-setting Federal Open Market Committee elected to leave the federal funds rate unchanged at a range of 5.25% to 5.5%, while mostly repeating language from previous statements describing the rationale for the move.

Notably, in projections released alongside the statement, 12 of 19 top policymakers expected one more interest rate increase this year to be justified. 

Some commentators have argued that the central bank is done with rate hikes already, but this is not the majority view among the officials.

However, the officials' expectation for interest rates at the end of 2024 was marked up, to 5.1% from 4.6% in June. Leaders of the central bank now expect to cut interest rates by less next year than they did three months ago.

What he's saying: Fed chair Jerome Powell continued to stress that policy makers want to see further improvements in inflation.

"We want to see that these good inflation readings that we've been seeing for the last three months, we want to see that it's more than just three months," he said at a press conference Wednesday afternoon. 

"Given how far we've come and how quickly we've come, we're actually in a position to be able to proceed carefully as we assess the incoming data, and the evolving outlooks and risks, and make [interest rate] decisions meeting by meeting," he added.

Between the lines: Fed officials are embracing a higher-for-longer strategy in which they only push interest rates slightly higher than they are now, but then hold those rates at elevated levels through most of next year.

The goal is to slow activity and keep inflation moving downward.

"Economic activity has been stronger than we expected, stronger than I think everyone expected," Powell said.

The median official raised their projections for 2023 GDP growth, to 2.1% from 1% in June, reflecting strikingly strong growth this summer.

The median also saw the unemployment rate rising only to 3.8% this year, not the 4.1% envisioned in June, reflecting a resilient labor market.

"Job gains have slowed in recent months but remain strong," the committee's statement said.

Fed officials expect inflation for the full year to be 3.3% this year and 2.5% next.

Of note: More top Fed policymakers now believe that the longer-term interest rate has risen, implying that rates will stay elevated well above the ultra-low levels of the recent past. 

Five top officials now believe that the longer-term rate is 3% or higher. Three held that view in June and zero did last year.

The median estimate of longer-term interest rates was unchanged at 2.5%, however.

Editor's note: This story has been updated to include comments from Fed chair Jerome Powell's press conference. 

Fed leaves interest rates steady, signals one more hike ahead

The central bank's leaders expect to keep rates high in 2024.

The Federal Reserve building. Photo: Celal Gunes/Anadolu Agency via Getty Images

The <a class="gtmContentClick" data-vars-link-text="Federal Reserve" data-vars-click-url="https://www.axios.com/2023/09/18/inflation-federal-reserve-whats-next" data-vars-content-id="fd1cd7b7-ab00-4864-bc4b-c77724dc0991" data-vars-headline="Fed leaves interest rates steady, signals one more hike ahead" data-vars-event-category="story" data-vars-sub-category="story" data-vars-item="in_content_link" href="https://www.axios.com/2023/09/18/inflation-federal-reserve-whats-next" target="_self">Federal Reserve</a> elected to leave interest rates unchanged Wednesday, and issued new projections indicating most officials anticipate one more interest rate hike this year.Why it matters: The central bank&#x27;s <a class="gtmContentClick" data-vars-link-text="18-month campaign" data-vars-click-url="https://www.axios.com/2023/08/16/federal-reserve-interest-rate-hike-july-minutes" data-vars-content-id="fd1cd7b7-ab00-4864-bc4b-c77724dc0991" data-vars-headline="Fed leaves interest rates steady, signals one more hike ahead" data-vars-event-category="story" data-vars-sub-category="story" data-vars-item="in_content_link" href="https://www.axios.com/2023/08/16/federal-reserve-interest-rate-hike-july-minutes" target="_self">18-month campaign</a> to slow inflation sent convulsions through financial markets and put economists on high alert for a recession. That campaign now appears to be coming to a close, though rate cuts appear far off.

Neil Irwin

Stories

Why rising long-term rates could ripple across the economy

Top Fed official sees "cautious optimism" in economic impact of AI

Fed officials see way out of inflation woes without major economic pain

Fed leaves interest rates steady, signals one more hike ahead

Where the job market is growing and shrinking in the U.S.

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