Investors are waiting on Friday's jobs numbers. They should be more worried about this other labor report.

By Hardika Singh

AI-driven productivity gains are hindering the Fed's effort to juice the labor market

AI is squeezing more work out of employees, giving companies less incentive to hire.

The artificial intelligence-led boom in U.S. productivity is making it harder for the Federal Reserve to breathe life into a languishing labor market.

Fresh economic data slated for release Thursday is expected to show that U.S. nonfarm productivity - measured by dividing output by the number of hours worked - rose at a 4.74% annualized rate in the third quarter of 2025, up from the previously reported 3.29% increase. If those estimates hold, it will be the highest level since the third quarter of 2020, when economic reopening from the pandemic sent workers rushing back and boosted productivity to 6.58%.

These productivity gains, coupled with an unemployment rate hovering at 4.6%, signal that companies are becoming leaner. In turn, increased efficiency allows them to be meaner toward prospective employees.

That's a double-edged sword for the Fed. While higher productivity can raise living standards for the workforce and lift the economy, its near-term benefits tend to be concentrated among those who are already holding jobs. On the other side are people who are struggling to get hired as businesses contend with economic uncertainty.

Consequently, even if the central bank lowers interest rates, it may not be enough juice to reduce the labor-market slack. (When corporations are able to grow their profits with the same number of workers, or fewer, there's little need to increase headcount.)

As such, it can be argued that trends in productivity are more important to watch than the release of the December nonfarm-payrolls report on Friday. The former can define the quality of the labor market, while the latter is just a snapshot of what's going on.

Since 1947, productivity has grown at an average rate of 2.22%, according to Max Motz, a macroeconomic-data scientist at Fundstrat. Since the 2020 pandemic shakeup, growth has averaged 2.03%. Many believe the postpandemic strength was mostly thanks to AI taking over the world in earnest beginning in 2023, sending productivity to 2.21%.

Expectations are that productivity could rise more in the years ahead, because AI adoption is still in the early innings. Plus, investment in generative AI as a percentage of gross domestic product still hasn't hit peak historical levels like it did for other transforming technologies such as railroads, auto infrastructure and telecoms, according to Goldman Sachs research.

That said, economists and central bankers have an ongoing intellectual debate to decipher whether AI is indeed the reason for the rise in productivity. Fed Chair Jerome Powell is increasingly leaning toward believing that's the case. At the central bank's most recent press conference, Powell gave his strongest indication yet that the higher economic growth that has been seen so far and that is expected to continue could be due to AI-led productivity gains.

"I think [AI] makes people who use it more productive," he said. That represents a changed tune from previous meetings. In September, for example, Powell said AI was "probably a factor" that contributed to lower labor demand and higher productivity, with a big emphasis on "probably."

Powell did add at the December press conference that AI productivity is complicating people's jobs. He said: "It may make other people have to find other jobs, though. So it could have productivity implications while also having social and labor-market implications that we don't have the tools to deal with."

The central bank's quarterly dot-plot release showed that the median Fed official expects real GDP to grow 2.3%, up from September's estimate of 1.8%. Meanwhile, participants' median forecast for where inflation could go, as measured by personal-consumption expenditures, the Fed's preferred inflation gauge, was lowered to 2.4% from September's projections of 2.6%.

The implication, according to Powell, is "obviously higher productivity." He added that "productivity has just been almost structurally higher for several years now. So if you start thinking of it as 2% per year, you can sustain higher growth without more job creation."

That means that even if the Fed delivers multiple rate cuts this year, the labor market may not benefit as much as some might be naively counting on.

Hardika Singh is an economic strategist at Fundstrat Global Advisors, an investment research firm. Read her disclosures here.

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-Hardika Singh

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01-07-26 1700ET