August 7, 2025

Every year, we slip into what are known as the “dog days of summer,” or the hottest and most uncomfortable days of July and August. The name derives from ancient Greek and Roman astronomy. It refers to the period when Sirius, the brightest star in the constellation Canis Major (the “Greater Dog”), rises before the sun.

The Romans referred to the star’s emergence as “dies canicularems” or “days of the dog star,” which later became “dog days.” They believed its proximity to the sun triggered the hottest and most unbearable days of the year, which were associated with droughts, lethargy and a general sense of chaos or unpredictability.

That seems an apt place to start, given another round of tariffs. Just as the Romans believed that the star Sirius triggered oppressive heat and chaos, tariffs are now fueling inflation, causing lethargy in the labor market and further sowing the seeds of uncertainty.

The personal consumption expenditures (PCE) index, the Federal Reserve’s favored measure of inflation, accelerated in May and June, moving further above instead of toward the Fed’s 2% target. The prices of the most tariff-sensitive goods jumped at their fastest annual pace since December 2022.

Payroll employment rose by an anemic 85,000 jobs per month in the first seven months of the year, less than half the pace of 2024. We are now within the margin of error for no job gains in 2025.

The unemployment rate edged up only modestly to 4.2% in July from 4.1% in June. That is close to an historic low and where it has been for more than a year. The demand and supply of workers have decelerated at the same pace, which is helping to keep the labor market in balance.

The question is whether it can stay there. The household survey, which is not subject to the revisions of the payroll survey, revealed that the duration of unemployment rose along with the ranks of the unemployed in July.

The long-term unemployed (27 weeks or more) jumped as a share of the labor force, which usually occurs after the economy has entered a recession. The stress measure of unemployment, which includes discouraged workers, jumped to 7.9% in July, well above the 6.2% pace of 2019. Could we already be in a recession?

This edition of Economic Compass takes a closer look at where we are in the rollout of tariffs, how long before the full effects kick in and how other policy shifts are likely to interact with tariffs. Headwinds are building for the remaining two quarters of the year.

Prospects for 2026 are better, aided by expansions to tax cuts and rate cuts by the Federal Reserve. We now expect two rate cuts prior to the end of the year, with a lot more in 2026. Rates could now drop well below the 2.75% to 3% range that is considered neutral.

The move up in the May and June inflation data and a surge in warnings about tariff-related price hikes suggest we are at a tipping point. We have moved from worrying about the dog days of summer to living them.

There are significant lags between when tariffs go into effect and how and when they show up in the economy:

1. The time between ordering and receiving an import – four to nine weeks. The first tariffs were levied in February but did not show up as a boost to revenues until April. Even then, the revenues were still low. Goods “on the water” or en route to the US prior to the announcements received waivers. That is in addition to front-running and the use of FTZs, which further delayed and dampened the boost to prices. 
2. Pass-through to prices – two to six months. Research on the 2018-19 trade war revealed that US firms and consumers bore all the costs of tariffs. The pass-through was rapid. Prices rose within months. Current tariffs are significantly larger, which suggests more cost sharing. Large companies have the leverage to gain concessions from suppliers; small firms do not. Those shifts and yet another round of tariffs suggest prices and costs will accelerate as we get into the final months of the year.
3. Supply chain shifts – six to 18 months. Firms tend to mitigate the effects of tariffs by reorganizing supply chains. That is costly and takes time. Gains in employment in the most protected industries are more than offset by losses in those without tariff protections; the latter tend to get hammered by higher input costs and the retaliation trade wars tend to trigger.
4. Losses to productivity and investment – one to three years. Five decades of data on 150 countries reveal that tariffs dampen investment and undermine productivity growth. Those effects take years to play out and diminish the economy’s potential to grow.

The AI boom is moving into bubble territory and could provide some offset to those losses, although tariffs increase the costs of building data centers. Full expensing of equipment in the tax bill may lower some costs, but not all.

Investment outside of AI has been lackluster. Persistently higher interest rates and a surge in policy uncertainty are the main reasons. Households and firms tend to delay big spending decisions, including hiring, when uncertainty spikes.

Those effects can linger, which compounds the blow to investment and productivity growth. That leaves the economy more brittle and susceptible to bouts of inflation.

Chart 3 shows the forecast for the federal funds rate. We now expect two cuts prior to the end of the year. September is not a slam dunk:

• The Fed’s credibility is at stake, as it never fully derailed the post-pandemic inflation. Political pressure to cut rates adds insult to injury.
• The Fed is still paying the price on its call that inflation would be transitory post-pandemic.
• The New York Fed’s survey on tariffs shows that firms expect to pass on a good portion of tariff costs.
• Spillover effects in the service sector cannot be ruled out.
• The unemployment rate is still historically low.

We are getting closer to a rate cut. Governors Christopher Waller and Michelle Bowman dissented in July, calling for a quarter-point cut. Concern about the labor market was the main reason.

New York Fed President John Williams, who is close to Powell in his views, is open to a modest calibration in rates. Two cuts before year-end would leave monetary policy in restrictive territory, while cushioning the economy from a slowdown in employment.

The pace of rate cuts will no doubt accelerate in 2026. Governor Adriana Kugler resigned early, leaving a seat open for the president to fill. He will appoint a loyalist. Congress is out for recess and will not take up that nomination before it returns in September. It is unlikely that a new member will be sworn in by the September 16-17 Fed meeting.

Once that person is in place, Powell could face three dissents among the Board of Governors if the Fed does not cut. That is unusual for the Fed. Former Fed Chairman Paul Volcker suffered a series of setbacks with his colleagues on the Board of Governors. He resigned not long after three voted against him in 1987. 

We now expect the Fed to cut rates seven times in 2026. A modest uptick in unemployment will be the primary reason. When combined with the two cuts in late 2025, that will lower the fed funds rate to a 2% to 2.25% range, which is well below current estimates of neutral.

We are entering an economic equivalent of the dog days of summer, when the oppressive heat of inflation threatens to return, as the job market stagnates. That is a toxic mix for the Fed, which is looking to balance the risks of escalating inflation and rising unemployment.

The uncertainty that hangs over the economy is like the heavy weight in the air as a summer storm approaches. Will inflation peak quickly or persist? Will the labor market remain balanced, or tip us into recession? How much can the Fed cut rates without risking a more prolonged bout of inflation?

If the Fed does cut more aggressively, what happens to its credibility and ability to stem inflation down the road? For now, the Fed sits on the fence, reluctantly waiting for more data as the star Sirius burns at its brightest. The heat and chaos associated with its appearance could bring the economy to a standstill.

Prospects for 2026 are better. Until then, drink lots of water, stay in the shade, dip your toes in the kiddie pool and if you have it in you, hug an economist. The dog days of summer are taking a toll on our collective moods. Be kind; pay it forward.