Monetary Policy & Inflation | US
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Summary
- As expected, the Fed cut 25bp, and against expectations added one cut to the 2025 dot.
- Chair Powell cited a shift in the balance of employment and inflation risks as the primary reason and characterised the cut as risk management.
- Powell did not commit to a policy path, reflecting the lack of clarity on economic trends and a lack of FOMC consensus.
- I think a fast increase in unemployment would see the Fed implement additional cuts to the SEP showing two more 2025 cuts.
Market Implications
- I expect three 2025 cuts, aligning with market pricing.
Shift in Balance of Employment and Inflation Risks
As markets expected, the Fed cut 25bp. Also, the FFR trajectory was lowered by 25bp during 2025-27 (market consensus expected an unchanged 2025 dot). Both the mean and the median 2025 dots fell, i.e., the FOMC overall turned more dovish (Chart 1).
The main rationale was, as expressed in the meeting statement, ‘a shift in the balance of risks’ as ‘downside risks to employment had risen.’ During the presser Powell explained that the more pessimistic employment assessment reflected data released since July’s FOMC, including the QCEW revisions.
Overall, the FOMC seems to have a more benign inflation view. Neither the meeting statement nor the presser introduction mentioned a change in assessing inflation risks. The FOMC base case remains for US tariffs to have a one-off effect on prices rather than a lasting inflation impact, though ‘risks must be managed. Also, the core PCE SEP forecast for 2025 was unchanged at 3.1%.
However, during the presser Powell added that, in his view, inflation risks had decreased partly due to the weaker economy. He added the ‘passthrough from tariffs to inflation has been smaller and slower than we thought.’ This small discrepancy between the meeting statement and presser introduction versus the Q&A could reflect a lack of FOMC consensus on inflation risks.
These changes align with my assessment of labour market and inflation trends.
| Chart 1: FOMC Turns More Dovish | Chart 2: Dissensions Increased! |
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A Risk Management Cut
The SEP showed one more 2025 cut relative to June’s two, even though 2025’s core PCE and unemployment forecasts were unchanged. During the presser, Powell explained this was because the cut was for risk management. The modal FOMC expectations had not changed but the downside risks to employment Powell had warned about at July’s FOMC had materialised.
A risk management cut was how I had justified yesterday’s move in my preview but I was expecting, with low conviction, a 50bp cut based on my estimate of the inflation/employment risk balance.
During the presser, Powell said ‘there wasn’t widespread support at all for a 50-basis point cut largely because FOMC members did not ‘feel that policy was out of place and needed to move quickly to a new place.’
I think another reason was disagreement on inflation risks among FOMC members, as mentioned above. Also, one FOMC member showed no 2025 cut, more likely to express unhappiness with yesterday’s cut than a belief in a Fed hike this year! Contrary to my expectations, the 2025 dot range widened to six cuts from previously three (Chart 2)!
Fast Unemployment Increase Would Trigger Additional Cuts
Powell stated the Fed would decide on further cuts ‘meeting by meeting’ and did not commit to a cutting cycle, even though the SEP forecasts four additional cuts over 2025-27. I think Powell’s unwillingness to commit to a set policy path reflects the lack of FOMC consensus and that the data remains ambiguous.
This week’s retail sales were strong and the Atlanta Fed GDP nowcast currently pegs Q3 growth at 3.3% QoQ SAAR (Chart 3). Yet the Conference Board Leading indicators have hit their recession trigger, consumption is flat relative to December, consumers are deleveraging and the Trump administration is implementing a de facto fiscal consolidation (Chart 4).
The direction of the economy will become clearer as more data becomes available. I would expect additional cuts if unemployment rises above the SEP’s 2025 forecast of 4.5%. This is because a fast increase in unemployment is one of the more reliable indicators of recession. Also, this is the SEP’s key message showing unchanged 2025 unemployment and inflation but a lower FFR.
One of the FOMC dots, most likely Miran’s, showed five additional cuts in 2025. To get that many cuts, the US economy would have to slide fast into recession, which is not impossible but unlikely. The lowest dot was unchanged in 2026 and in 2027 and only 25bp lower than in June’s SEP.
Market Implications
I expect three 2025 cuts, aligning with market pricing.
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