Top economist Diane Swonk: Jerome Powell risks losing the Fed’s credibility on a gamble about AI and immigration

Federal Reserve Chair Jerome Powell warned the U.S. labor market may be weaker than headline data indicate, but KPMG chief economist Diane Swonk cautions the Fed is likely misreading that weakness as demand-driven rather than structural—driven by AI adoption and sharply lower immigration—which means further rate cuts could fail to restore jobs, undermine the Fed’s inflation-fighting credibility and actually boost inflation. The warning follows a fractious FOMC that cut rates a quarter point to 3.50–3.75% with three dissents (one for a larger cut, two for no cut), and Powell acknowledged AI and lower labor supply are part of the story though he called them limited so far. Swonk also flagged fiscal risks—large 2026 tax refunds and record debt issuance—that could entrench inflation and rattle bond markets if the Fed pauses too soon while markets are pricing in more easing.

Analysis

Federal Reserve Chair Jerome Powell signaled the U.S. labor market may be materially weaker than headline data imply, while the FOMC proceeded with a 25bp cut to a 3.50%–3.75% policy range for the third consecutive meeting. The vote produced three dissents—the first since 2019—with Governor Stephen Miran favoring a 50bp cut and Presidents Jeff Schmid and Austan Goolsbee preferring to hold, and the statement reintroduced language signaling a potential pause.

KPMG chief economist Diane Swonk argues the Fed risks misattributing cooling hiring to weak demand when structural forces—AI-driven automation and a sharp decline in immigration and participation—may be primary drivers; she cautions that rate cuts cannot create workers or reverse automation decisions and therefore could undermine the Fed’s inflation-fighting credibility and raise inflation. Powell acknowledged AI is "part of the story" but called it limited so far.

Swonk also highlights fiscal cross-currents that could complicate policy: tax-cut expansions are likely to produce record-high tax refunds in early 2026 and federal debt is projected to surpass GDP, increasing the burden on bond markets. Market pricing for additional cuts coupled with internal Fed dissent raises the probability of dislocated bond markets and policy risk if incoming data do not support a demand-driven slowdown.

Key Decisions for Investors

• Reduce unhedged long-duration sovereign exposure and add rate-hedges given the risk that market-priced easing could be met by renewed inflation and bond-market skittishness
• Shift toward higher-quality, liquid fixed-income and shorten portfolio duration until employment revisions and inflation prints clarify whether weakness is structural or cyclical
• Avoid increasing cyclical consumer exposure on the assumption that rate cuts will restore hiring; favor companies with pricing power or clear AI productivity advantages that mitigate labor-driven demand risk
• Use incoming employment revisions, immigration/participation data, and early 2026 fiscal flow indicators (tax-refund timing and debt issuance) as explicit triggers to re-risk or hedge portfolios