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This article is from Monetary Policy Radar, a new product from the FT designed to help investors anticipate monetary policy decisions.
The Federal Reserve is poised to lower interest rates on September 17 in what markets expect to kick off a series of reductions that will fuel the US economy for the rest of this year.
At a time of acute political pressure on US central bankers, Fed chair Jay Powell signalled his support for a pivot towards rate cuts at the annual Jackson Hole symposium in August.
But with inflation rising on the back of Donald Trump’s tariffs and with already frothy financial markets, the danger for the Fed is that loosening monetary policy significantly will damage its inflation-fighting credibility.
The FT’s Monetary Policy Radar view therefore is that the Fed will initially be cautious, cutting rates by a quarter point in September to a range of 4 to 4.25 per cent and signalling that it remains vigilant to deal with two-sided risks — inflation and maximum employment — for the rest of this year.
We expect a pause thereafter with another cut in December, before a sequence of cuts in 2026 as the president gains influence on the Federal Open Market Committee and insists that his appointees, including a new chair who will start next May, vote for lower interest rates.
The main risk to our central scenario is that rates are cut at a faster pace, raising the threat of a difficult subsequent inflation shock. This was highlighted in a regular internal challenge to our scenarios, by the FT’s economics columnist, Martin Sandbu.
The data
In his Jackson Hole speech, Powell spelt out the stagflation challenge. “In the near term, risks to inflation are tilted to the upside, and risks to employment to the downside,” he said. The tension between both sides of the Fed’s mandate is clear in the latest data.
The employment report last week showed much weaker jobs growth, with only 22,000 jobs added in August, far less than expected. Job gains from previous months have also been revised sharply downward.
But with unemployment rate rising only from 4.2 per cent to 4.3 per cent over the past year, the labour market is still warm. This pattern is replicated in many other labour market indicators that we track at the Monetary Policy Radar. They are also still above their 2001-2019 average although they have also been getting less strong, giving Fed rate-setters more leeway to trim interest rates.
Meanwhile, inflation is beginning to rise as Trump’s tariffs get passed gradually through to consumers and remains well above the Fed’s 2 per cent target. Headline CPI rose to 2.9 per cent in August and the proportion of goods and services with rising prices has risen sharply.
The FT’s measure of core inflation — which combines multiple underlying measures together in a statistically optimal way — reached 3 per cent in August, reinforcing our view that the Fed’s fight against inflation is not yet over.
Central bankers’ views
At the annual Jackson Hole conference in late August, Powell’s keynote speech was dovish. “With policy in restrictive territory, the baseline outlook and the shifting balance of risks may warrant adjusting our policy stance,” he said.
Since these words, several other Fed officials have also pivoted with their evolving views captured in our database of central bankers’ views, showing more concern about weak jobs growth than rising inflation.
Even some normally hawkish policymakers have opened the door to lower rates, leading to a change in the balance of views within the Fed. Although views are still divided, a hawkish pivot earlier this year has reversed in recent weeks in our hawks-dove scale.
Alberto Musalem, the St Louis Fed president who has voting rights on the rate-setting FOMC in 2025, indicated last week that “recent data have further increased my perception of downside risks to the labour market”. A few weeks earlier, Musalem had sat on the fence.
New York Fed president John Williams, a centrist, recently also indicated he could see the case for further cuts, though he stopped short of specifying when. Last Thursday, he said that he was “not seeing signs of amplification or second-round effects of tariffs” and that “if progress on our dual-mandate goals continues [ . . . ] it will become appropriate to move interest rates towards a more neutral stance over time.”
Other policymakers have remained more circumspect about the merits of a rate cut. Among the holdouts is Austan Goolsbee, who will vote at the next meeting and who said last Friday that price pressures remained a concern. “I want to get more information. I’m still undecided,” he told Bloomberg TV.
Analysts’ views
Many analysts changed their views on interest rates after Powell spoke at Jackson Hole. Even those who expected rates to stay on hold all of 2025 began to fold.
“If the Fed does lower interest rates as we now predict, strengthening inflationary pressure while the labour market remains roughly in balance should still ensure that it will keep interest rates on hold from its December meeting onwards,” said analysts at Berenberg, after shifting their position to expect two cuts this year.
Bank of America needed more convincing and only pencilled in cuts after the latest August jobs report, stating that “stagflation makes the policy outlook bimodal. The Fed has so far been more worried about inflation than the labour market. But Powell’s speech indicated a potential regime shift towards prioritising the labour market. Today’s jobs data should cement that shift.”
The shift in analysts’ views is reflected in financial market pricing, which now is unanimous in the view that rates will fall a quarter point at the September meeting with a majority expecting three cuts this year.
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