MNI POLICY: Lingering Inflation Unease Tempers Fed Easing Push

The Federal Reserve is set to cut interest rates for a second straight meeting next week, but the easing trajectory will be tempered by caution due to persistent inflation pressures. 

Most Fed policymakers are willing to trust the idea tariffs will be a one-time move in the price level, comforted by solidly anchored long-run inflation expectations. Yet the process by which trade-driven cost increases are passed through to consumers has been gradual, contributing to stickier inflation. Escalating tensions between the United States and China in recent days also threaten to reignite fears of inflation persistence.  

Hawks like Kansas City Fed President Jeff Schmid point out price pressures are broadening in spite of the relatively muted effect of tariffs. And even some officials who are penciling in a third rate cut this year are waiting to see whether inflation will peak around 3% before supporting further cuts next year. (See MNI INTERVIEW: Fed Right To Remain Cautious On Rate Cuts-Kohn)

That the neutral rate is uncertain and thought to be only a percentage point or so below where the fed funds rate currently sits adds to policymakers reservations about the pace of future cuts. It suggests that after the current phase of risk-management cuts, the Fed's path forward may not match the aggressive downward trajectory markets are pricing. 

"If we move too quickly, then we may leave the inflation job unfinished and have to come back later and finish it. If we move too slowly, there may be unnecessary losses – painful losses – in the employment market. So we're in the difficult situation of balancing those two things," Fed Chair Jerome Powell said last week.

NOT SO RELAXED

The Fed's own trend inflation gauges suggest more sustained upward pressure, while businesses continue to tell the Fed they intend to pass along cost increases eventually. 

Trimmed-mean PCE inflation has been 2.7% for the three months through August, while the Cleveland Fed’s median PCE inflation reading has been above 3% since 2021, and was at 3.3% in July and August. The NY Fed’s multivariate core trend measure jumped to 3.1% in August from 2.8% in July, primarily driven by increases in services ex-housing and core goods, the bank said.

Firms in the Atlanta Fed district "warned that price passthrough resulting from tariffs has just begun and expect to see prices rise into 2026," according to the October Beige Book. Retailers in the Chicago Fed district said they were "trying to hold off passing tariff-related cost increases on to consumers for as long as possible." 

Governor Chris Waller, who has argued from the start that tariffs won't have a lasting impact on inflation, last week cited a different reason to be vigilant: stronger-than-expected growth stands in conflict with a weakening labor market. 

If growth holds up or accelerates and the labor market recovers, it might be an indication that policy is less restrictive than thought and cuts need to be slower than he had expected, he said, also noting that the government shutdown has delayed economic data, complicating the Fed's analysis.

"What I would want to avoid is rekindling inflationary pressure by moving too quickly and squandering the significant progress we have made taming inflation,” he said.