The US economy is navigating some tricky waters right now, with still high inflation, a weakening labor market and an evolving policy landscape making the outlook and the Fed's next steps quite uncertain.
My guest today is Robert Kaplan, vice chairman of Goldman Sachs and former president of the Dallas Fed.
Rob, welcome back to Exchanges.
Good to be with you.
So, Rob, let's start right in with the Fed.
Chair Powell made some pretty hawkish comments after the last FOMC about the prospect of a December rate cut.
It surprised some people.
We in Goldman Sachs Research are still expecting a cut in December.
The market seems somewhat less convinced.
What's your read on those comments?
So you may know, going into the October meeting I had been saying that the market expectation of a further rate cut in December the probabilities are of that rate cut were, to my eye, way too high.
It doesn't mean the Fed won't cut rates in December, but I think it's a much tougher decision.
And so I was glad that Jay in the press conference balanced the decision a little bit more and left the Fed more time to really debate this out.
And you see more articles about a split in the committee.
It's understandable.
So what's the split about?
The labor market is weak.
We know that.
And Jan Hatzius has very eloquently explained that weakness and hiring is down to stall speed.
And why is that?
There's three big headwinds that are creating that weakness.
One, tariffs in the near term, at least in my opinion, are slowing growth.
And we could go through much more detail, but for purposes of this call, they're having the effect of causing big businesses to do somewhat less.
They're having a more pronounced effect on small businesses and we're seeing that.
In addition, it's not just a cutoff of lax immigration, which I think is probably a very constructive thing.
There are 12 to 15 million workers in this country, who make up a big chunk of construction agriculture services, who are here on provisional status.
They're not here illegally, the great bulk of them, but they're on some kind of temporary status.
And many of them are unsure whether they're going to be allowed to stay.
Many of them I hear from employers we hear are not showing up at work.
They're not sending their kids to school.
They're definitely not shopping at the mall.
That's a loss of income.
So those two things are headwinds.
And then we got a new headwind over the last 45 days, which was the government shutdown, which obviously reduces incomes, reduces growth.
And so it's understandable that you see a lot of sluggishness.
At the same time, we've got three tailwinds coming into 2026.
One is tax incentives tax on tips, tax on overtime, accelerated depreciation kicking in early next year.
You've got regulatory reform, which has started but hasn't reached full throttle.
That will help growth.
You have the obvious AI data center power boom that we've talked so much about is fueling growth.
And now one of the headwinds, which is the government shutdown, is going to fortunately go away.
It may not become a tailwind, but it'll reduce that headwind.
So it's unclear to me how weak the labor market actually is versus these headwinds and tailwinds we might see affirming into next year.
And so that's on the one hand.
On the other hand, to put it in short, inflation's running 7500 basis points above target two and three quarters to three.
There's an enormous amount of debate as to whether inflation is already embedded in some of that.
Maybe it's temporary and maybe it'll elapse over time.
But I can tell you, talking to businesses, there's a lot of disagreement on that issue.
And many businesses.
I talk to think that a lot of the tariffs won't actually be felt in terms of price until 2026.
So the Fed's got to debate both sides of this.
Both are unclear and they're getting close to neutral, which is why the urgency of this debate heightens.
And ultimately Powell gave more room basically in those comments, to wait and see how some of this evolves.
Yeah.
And I would actually add one thing.
There are times where the views of the group matter and he's got to reflect those.
I think when you go into an agonizing decision like we're heading into December, where there are pro and cons arguments and there are legitimate arguments on both sides, what Chair Powell wants to do will have outsized influence and that there are many people on the committee that will vote.
There might be 55, 45, 60, 40.
And if he feels strongly one way or the other, they'll be inclined to back him.
And my guess is it wouldn't surprise me if he hasn't decided yet what he wants to do.
It's going to be a game time decision right up until December 9th and 10th.
There's a lot to unpack there Rob, and I want to ask you some follow-up questions about many things you just said.
But let's just take a step back.
As you mentioned, government shutdown, it's been the longest shutdown on record.
It's come to an end this week.
But in the meantime, there has been this vacuum of data.
And so that in itself must be complicating the Fed's decision-making process.
Talk to us a little bit from your experience as a former president of the Fed.
How does the Fed even go about navigating this lack of data amid these headwinds and tailwinds, as you just pointed out?
So the Fed loves data.
The Fed is led by predominantly PhD economists, just a few business people.
And they like data because they can fit it into models.
And that data is very valuable.
And it confirms what you're hearing from business and what you're seeing in your own work.
And they don't have that.
My guess is when we do get data.
It wouldn't surprise me if that data confirms the sluggishness I talked about earlier.
But they don't know.
And so that makes their job harder.
That means they've got to do more to look at private sources.
They've got to talk to businesses more.
That's anecdotes.
It would sure help to get more comprehensive data to confirm those anecdotes.
Let me just ask you a bit more about the labor market, which you've mentioned.
But ultimately, as I hear you talk about it, Are you thinking that this is mostly cyclical factors or more structural?
I heard both, Rob, entering into your comments as you're thinking into 2026.
You heard both because I think it's unclear.
It's unclear to me, which it is.
It really is.
And I think it's clear and clear to many others that I speak with.
I don't hear businesses tell me that business has fallen off a cliff.
I hear it's sluggish, but almost every business I talk to and checkings I do suggest that business is okay, not great.
And so it doesn't feel like a cyclical slowing.
I do hear lots of matching issues, ie college graduates are struggling to find jobs, but also I hear lots of open jobs that businesses can't fill.
The problem is the people that are looking for jobs don't want to be window installers.
So we do have a matching problem.
And so to me, If it turns out that a lot of this weakness is matching related, I don't know that monetary policy is the tool to deal with a matching issue.
I think some of the weakness is slowing and the shutdown has further exacerbated that.
But again, the shutdown is a temporary factor that's going to recede.
And then you've got these tailwinds going into next year.
So it's confusing.
And the short answer to your question is, I don't know.
And that's the problem.
I don't think there's great conviction.
So then it becomes a risk management exercise.
Understood.
And to your point, we are now a fair way into the third quarter earnings seasons.
Earnings have been quite good.
So there aren't too many signs that companies are falling off the cliff.
And that's true, not just in the U.S., but globally.
Yeah.
And just to further reinforce that, in the prominent cases of large layoffs announced, a number of them have been accompanied by solid sales.
Okay.
I won't mention names of companies for this purpose, but you can think of some of the examples.
It's belt tightening, other things, not a cyclical slowing.
Understood.
But even as we think about those earnings, when we think about the inflation question that you've already begun speaking about, ultimately it's our impression that companies have largely so far been absorbing some costs, like the tariff costs that have been such a big concern this year.
But is there a point at which the companies start passing those costs onto consumers?
And is that a reason to be more concerned than maybe we are, the markets are, about inflation ahead?
It seems like the market really wants to put inflation concerns on the back burner at this point.
But is that too premature?
Most of the CEOs I talk to.
Yes, many have said they're taking it out of margin and they're gonna try to get it back in price in the near time.
They're doing belt tightening.
For some of the small businesses, it's probably more dire than that, in that they don't have the option to take it out of margin and they're struggling with whether they're gonna stay in business for the next year or two.
Many other businesses explained to me there was a restocking pre-tariff implementation.
We're now in the destocking phase, but we're getting through destocking And many businesses have talked to me about the fact that they believe into 2026.
That's when you'll see more tariff impact.
Our own economists have a view that maybe we're half or 60% of the way through.
And that's another one, the honest answer is, I don't know.
I'm also seeing service sector businesses telling me that some of these cost increases are bleeding into their business.
Also, it's bleeding into services.
So you may remember services.
It's been running about mid threes, three and a half percent and is sticky.
A lot of the improvement of inflation the last few years has been goods disinflation.
The tariffs have interrupted that goods disinflation.
And so that's the reason why we're going sideways, and we're going to go sideways probably for a while.
And many argue that latter half of next year, you'll start to see disinflation kick in.
But in fairness, that's a leap.
That's a leap of faith.
And I think there's uncertainty about that.
So, yes.
So it seems like you are maybe not as convinced that inflation is something we should be less worried about.
I'm not.
And so here's why all this I mentioned earlier gets heightened.
If we were at five and a quarter, five and a half, you know, got lots of room to cut.
My own view, and you've heard me say this before, is the neutral nominal Fed funds rate.
It's inflation rate. plus a real Fed funds rate.
There's pretty good consensus that the real neutral Fed funds rate is somewhere between three quarters of percent and 1.
And I haven't heard a lot of counter arguments to that.
So then the question is, what's the underlying inflation rate?
Those who say the neutral rate is closer to two and three quarters, they're assuming inflation gets to 2.
The problem is it's not at 2% right now.
It hasn't been for a few years.
It's at two and three quarters to three.
And so that makes me believe that currently the nominal neutral rate is about three and a half, three and three quarters.
The Fed is at three and three quarters to four right now.
Do you really wanna be at neutral with inflation running this much above target?
And I think that would, in my former seat, make me very uncomfortable and would make me really wanna be confident more confident than I am right now about what's going on in the labor market.
So Goldman Research is expecting a couple more cuts in 2026.
The market, I think, if I checked my screen correctly, is expecting three more cuts in 2026.
Given all this, I mean, where do you think the risk lies relative to those expectations?
So you may know I've been saying for the last couple of months I probably, I don't know, but I would take the under.
And the reason I would take the under is because The only way that I see the Fed doing, or should be doing, two to three more cuts.
The only reason I would be willing to do this is if I were convinced that we were in the midst of a very severe labor market weakening, more severe even than it appears to me today.
That would cause me to cut more.
Or over the horizon, we're going to make real improvement on the inflation rate.
So this two and three quarters to three is going to come down.
I've got to be convinced at about one of those or both.
And at the moment, I'm not, which is why I've been arguing, be careful.
I think the market is overestimating the probability of rate cuts.
Interesting.
Let me take a second Rob, and ask you about a very topical subject at this point in time Fed independence.
Obviously, this administration has a clear preference for lower interest rates.
Has that had any bearing on the decision-making process?
The Fed this point from what you can observe.
It probably has had a little bit of impact on the margin.
I know around the table at the Fed people are doing their level best to screen out political pressure, political influence.
And I think they've done that.
I think this is all coming to a head though in December.
In that that pressure, I think they're going to do their level best to screen it out.
But this is a tough decision.
Even without that pressure, I would find the December decision if I were in my this is an agonizing decision.
And so, for me, what they're going to struggle with is, from a risk management point of view, one argument would be skip December.
If it turns out the labor market I'm wrong and the labor market is weaker, then we'll act in January.
However, the backlash and the tension will escalate.
Obviously, I think they've got to screen that out.
The problem is, if you do cut in December which I still think is, I agree, is more likely than not that they will.
The problem is now I'm at neutral, in my opinion.
And if it turns out that we get a firming in the labor market next year and inflation turns out to be stickier, I'm out of position.
I don't want to be at neutral.
I want to be at least modestly restrictive.
So that's why I say it's an agonizing decision.
And as you said, the politics are on their minds, but certainly not the driving factor.
In the back of their minds, not the front of their minds.
Right.
But we will have new Fed leadership soon.
And so at that point, are concerns about Fed independence likely to grow?
Should they grow?
Are you concerned at all looking ahead at Fed decision-making from that perspective?
Listen, I think concerns when I talk to capital allocators, investors globally there's no question that concerns are about Fed independence have grown.
It may be one of the reasons why gold has rallied 50% plus.
It may explain some of the things that we're seeing.
I think you've heard me say before even with a new chair, the culture of independence inside the Fed on setting monetary policy decisions is very strong.
And so I think it would take a lot to change that culture.
I mean, a lot of personnel changes.
I do believe regulation is not politically independent, and it has been for many years, and so that makes sense.
I don't think there's gonna be a big issue there.
I think you may see some changes on the way the balance sheet is managed, in that it would not shock me with a new Fed chair.
There'll be more active discussion about extending the average maturity of the Fed portfolio.
In other words, owning less short, buying more long.
The Fed is not going that way at all so far right now, but with a new Fed chair I would guess that'll be revisited.
I'm not troubled by that.
I think that might actually be a constructive debate.
But on setting monetary policy, you would need meaningful changes in personnel in order to change the independence that I think is still actively there.
So Rob, just to conclude, you've talked a lot about cross currents, different forces pulling in different directions.
What are you watching most closely over the next couple of months?
That will be important for the Fed's decision making.
So I'm going to really be trying to get a feel for the end of the shutdown government workers starting to get paid, flight disruption starting to calm down.
What's the impact and how long is the imprint of that likely is going to take for that to resolve?
And I'm expecting it means that maybe the next couple of months are going to be on the weak side, but I'm expecting that.
So I'm watching that.
Talking actively to business.
What I'm watching for also is Is business and consumer spending getting weaker?
Is business weakening?
Understanding.
There's two groups of consumers low, moderate income and more fluent and they're spending in different ways.
Watching that.
And then I'm going to watch very carefully and talk to businesses.
What are they seeing?
Not only in goods, but in services more, because that's the bulk of the economy.
What are they seeing in terms of costs and what is their thinking on prices?
And so those are the kinds of things, at least in regard to monetary policy, I'm going to be looking at.
Thanks so much, Rob.
We have lots of conversations, you and I, and every single time I learn not just one thing, but several things.
Thanks so much for joining us again.
Dr. Allison, thank you.
Thanks for listening to this episode of Goldman Sachs Exchanges, which is recorded on Wednesday, November 12th 2025.
I'm Allison Nathan.
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