MNI POLICY: Fed Takes Measured Approach To Post-September Cuts

Federal Reserve Chair Jerome Powell has signaled the central bank is ready to cut interest rates in September, but a divided FOMC will carefully weigh the need for and timing of any subsequent reductions because inflation remains too high for the Fed's comfort. 

Some FOMC members are sufficiently worried about the labor market to support more aggressive cuts, while others remain cautious about direct and second-round effects of tariffs-driven price hikes, which have boosted core PCE inflation to an estimated 2.9% in July, above its year-ago level. 

Middle ground could be found in a measured pace of rate reductions, as officials watch how higher costs flow through the supply chain and take stock of further cooling in the labor market as demand weakens. Uncertainty within the FOMC about the destination for borrowing costs – including just how far they are from neutral – provides further grounds for gradualism.  

“The stability of the unemployment rate and other labor market measures allows us to proceed carefully as we consider changes to our policy stance,” Powell said in his speech at the Kansas City symposium. "Nonetheless, with policy in restrictive territory, the baseline outlook and the shifting balance of risks may warrant adjusting our policy stance." 

INFLATION TOO HIGH

The price effects of tariffs have been somewhat muted so far, as firms pulled forward purchases and delayed having to raise prices. Now that demand has cooled in the second half, business leaders are keen to preserve market share, knowing consumers are feeling stretched. 

Still, surveys and anecdotal evidence signal prices will rise further, and some firms not directly affected by tariffs also anticipate raising prices along with their competitors – mechanisms that could see price pressures spreading. 

Core non-housing services CPI spiked 0.5% in July after coming in at a three-month average rate of 0.25%, setting off concerns among some Fed officials that tariff effects aren't staying in their lane. A record high 2.6% jump in dental services prices in the month may be traced partly to the higher cost of imported dental supplies, for example. (See: MNI INTERVIEW: Fed Inflation Woes Extend Beyond Tariffs-Lacker)

RISKS MORE BALANCED

Views differ among FOMC officials over whether a still-low U.S. unemployment rate of 4.2% masks more weakness in the labor market. 

Some employers are allowing attrition to whittle their payrolls, and some are choosing to invest in technology instead of hiring. That the supply of workers has slowed at the same time due to immigration curbs and retirements has kept the labor market in what Powell called a "curious" balance. (See: MNI POLICY: Job Revisions Pressure Fed To Cut In September)

Quits rates and vacancies continue to look reasonably healthy, assuaging fears of an imminent deterioration in jobs. At the same time, a less tight labor market creates fewer conditions for wages-driven inflation.  

"We can cut now and see how the data evolves," Fed Governor Chris Waller said after dissenting in favor of a cut in July. "If the tariff effects do not lead to a major shock to inflation, the Committee can continue reducing the rate at a moderate pace. If we do get significant upside surprises to inflation and employment, we can pause."