SF Fed president warns of possible unemployment spike

When it comes to the unemployment rate, be prepared for pain ahead.

That was the message from Mary Daly, the president of the Federal Reserve Bank of San Francisco, during a talk in The City on Monday at Commonwealth Club World Affairs of California. Thus far, the Federal Reserve’s move to raise interest rates has reduced inflation without significantly increasing unemployment, Daly said.

But the easy part of the fight against inflation “may be coming to an end,” she said, and getting the rate down to the Fed’s target of 2% from above 3% today could well lead to mass job cuts.

“So far, the adjustments in the labor market have been modest” in response to the rise in interest rates, Daly said at the event, which was sponsored by the San Francisco Press Club. But, she continued, “we’re getting nearer to a point where the outcomes on employment may be less benign.”

The inflation rate started spiking in 2021, amid pandemic-related supply-chain constraints, labor shortages and the Fed’s own loose money policies, which were meant to revive the economy after the recession spurred by the COVID-19 lockdowns. Inflation hit 9.1% in mid-2022 , a rate not seen in nearly 50 years .

In response, the central bank started tightening the money supply in early 2022 in a succession of interest-rate hikes, one of its quickest ever. From February 2022 to August 2023, the federal funds rate — the borrowing rate that the Fed controls — jumped from about 0% to north of 5% .

Those moves, plus a moderation in the supply-chain issues the economy faced, have gone a long way toward getting inflation under control, Daly said. The annual rate dropped to 3% in June a year ago and has hovered between there and 3.7% in the months since.

But the rate still hasn’t gotten down to the Fed’s target rate, she noted.

Compared to even a year ago, “we’re in a different place. I’d offer a better place,” said Daly, who’s headed the local Fed branch since 2018 . However, she said, “There’s more to do.”

So far, the Fed’s moves haven’t caused a lot of pain in terms of job losses, at least not nationwide. While numerous Bay Area businesses — including Meta, Alphabet and Salesforce — have cut thousands of jobs over the last two years, the nation’s employers on the whole have generally avoided layoffs. Instead, in response to the slowing economy, they’ve been reducing their hiring and cutting vacancies, Daly said.

As a result, the national unemployment rate has stayed fairly steady. In June 2022, it was at 3.6%. As of last month, it stood at 4%.

California’s unemployment rate rose from 4.5% in May last year to 5.2% last month. San Francisco’s rose from 2.8% to 3% over that same period.

But businesses are likely running out of vacancies to cut. The economic model the Fed uses and the historical data the model is based on suggest that if the economy slows down further, businesses will increasingly resort to job cuts, Daly said.

The central bank is charged with maintaining stable prices and maximizing employment. Going forward, that’s going to be an increasingly difficult challenge, she said.

“At this point, inflation’s not the only risk we face,” she said. “We will need to keep our eye both on inflation, that part of our mandate, and on full employment, the other part of our mandate.”

That said, the Fed is determined to get inflation down to its target rate of 2%, she said. Given the natural imprecision of economic data, especially as it’s being assessed in real-time, that goal offers an ideal level of inflation, she said — it’s not so low that the economy could actually be dipping into deflation, a dangerous situation that can undermine growth, and it’s not so high that people feel the impact of rising prices.

The economy is at its best when people at large aren’t thinking about inflation, she said.

“I’ve been happiest when people don’t know what the word means,” Daly said.

But at this point it’s unclear how the Fed will reach that goal, she said — it could be that inflation remains above the central bank’s targets longer than expected, in which case the Fed will have to maintain higher interest rates for longer than anticipated. On the flip side, inflation could rapidly fall or unemployment could suddenly spike, in which case, the Fed might need to cut rates rapidly.

Or inflation could decline slowly, and the central bank could gradually cut rates, as many investors and analysts have been expecting it to do.

“Any of the three scenarios I just described are in the realm of reasonable,” Daly said. “Any of them are possible. And we will need to respond to however the economy evolves.”

In terms of the local economy, Daly scoffed at the idea that San Francisco is in a so-called doom loop . When the dot-com boom went bust at the turn of the millennium, skeptics similarly thought that San Francisco and Silicon Valley’s best days were behind them, she said.

The area retains many of the same advantages that helped it recover then, she said — San Francisco is a beautiful place to live, with a talented workforce and an innovative and entrepreneurial spirit. And, she said, The City is already starting to bounce back.

San Francisco and the region obviously have challenges — housing costs and high office vacancy rates, among the most notable, Daly said, but housing is a nationwide problem. AI companies are starting to fill The City’s office vacancies, and local business owners can help address the vacancy rate — and spur the local economy — by encouraging their workers to come into their offices, she said.

“There’s a lot of things that we need to do to make this city better and live up to its potential and to make the surrounding area better and live up to its potential,” Daly said. “But I just know that the spirit is here, and the job will get done.”

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