FOMC Review: Powell Lays Ground for September Cut

Summary

• The Fed did not cut as expected.
• Chair Powell prepared the ground for a September cut with a more positive inflation outlook and an acknowledgement of downside labour market risks.
• If unemployment remains within the current range, my base case, a 25bp cut is likely at September’s FOMC.
• Following the meeting, market pricing of a September cut fell to 40%, from 60% before the meeting. I think the market is mistaken largely because it believes the Fed is focused on price increases rather than future inflation and because it sees the Fed as more focused on asserting its independence than on managing the economy.

Market Implications

• I still expect two-three 2025 cuts and at most one 2026 cut, against markets pricing 1.5 and three cuts, respectively.

Fed Concerned About Future Inflation Rather Than Current Prices

As expected, the Fed remained on hold and Vice Chair Bowman and Governor Waller dissented. Powell described the discussions as ‘very thoughtful’ and viewed the meeting as ‘one of the better meetings I can recall from that standpoint.’

The dissents attracted much attention because they are unusual but, with President Trump set to appoint dovish Fed governors, they could become a regular feature of FOMC meetings.

The Fed is concerned about risks of current tariff-induced price increases becoming lasting higher inflation rather than about current price increases (Chart 1). Powell said so during the presser:

‘We will, through our tools, make sure that this does not move from being a one-time price increase to serious inflation.’

The only way for the Fed to be sure the tariffs will not have a lasting effect on inflation would be to wait until well after the Trump administration has fully implemented its desired tariff schedule. However, this is not feasible as this would take time and meanwhile employment risks could rise.

So, the Fed must adopt a risk management approach and weigh risks of higher inflation against those of weaker employment. While doing so, it will look for signs the price level increase is becoming a broad-based inflation acceleration, mainly increases in prices of services and non-tariffed goods as well as wage inflation acceleration (Chart 2).

Chart 1: Fed Focused on Inflation Not Prices	Chart 2: Services Prices Offset Tariffs Impact

Powell laid the ground for a September cut during the presser, aligning with my expectations.

Fed More Sanguine on Inflation Risks

Powell made clear the Fed is less concerned about inflation risks than it was in June. The presser statement said:

‘A reasonable base case is that the effects on inflation could be short-lived – reflecting a one-time shift in the price level. But it is also possible that the inflationary effects could instead be more persistent, and that is a risk to be assessed and managed.’

By contrast, the whole June presser conveyed more uncertainty on inflation. For instance, June’s presser statement did not have a price level increase as its base case. Instead, it said:

‘The effects on inflation could be short lived – reflecting a one-time shift in the price level. It’s also possible that the inflationary effects could instead be more persistent’

Furthermore, yesterday Powell saw no sign of broadening of inflationary pressures. He said:

‘In the first administration of President Trump washing machines were tariffed, but dryers weren’t, but what do you know? The price of dryers went up too, just like washing machines. We don’t see a lot of that.’

‘We know from surveys that companies feel that they have every intention of putting this through to the consumer. But, you know, the truth is they may not be able to in many cases.’

‘Wages are still at a healthy level but moving ever closer to what we would regard as long run sustainable, consistent with longer run productivity and 2% inflation.’

By contrast, in June’s presser Powell said:

‘Real wages after inflation have been moving up sort of more than was consistent with 2 percent inflation.’

Fed More Concerned About Employment Risks

During the 45-minute presser, Powell mentioned ‘downside labour market risks’ six times. This assessment was mainly because unemployment had remained stable, and the labour market was ‘solid’ for the wrong reasons. Labour supply had fallen in sync with weaker labour demand.

Furthermore, Powell mentioned private job creation had slowed and that without the BLS birth death model estimates it was ‘close to zero’ (Chart 3).

By contrast, during June’s presser Powell did not mention downside labour market risks. Instead, the presser statement included the sentence:

‘The labour market is not a source of significant inflationary pressures.’

The sentence was dropped from July’s presser statement.

An additional source of downside risk to employment were risks to GDP growth. The FOMC statement noted the H1 growth slowdown (Chart 4). During the presser Powell stressed the consumption slowdown, which drove the GDP slowdown, could last, though the consumer was in reasonable shape:

‘Consumer spending had been very, very strong for the last couple of years and forecasters, not just us, had been forecasting it would slow down, and now maybe it finally has. If you talk to credit card companies, they will tell you that the consumer’s in solid shape. So essentially, you have a consumer that’s in good shape and is spending, not at a rapid rate. It’s one of the data points that we pay most careful attention to, and there’s no question that it’s slowed.’

Powell also stated he did not expect much fiscal impulse from the ‘One Big Beautiful Bill’ because it consisted mainly of extending the current tax regime.

Chart 3: NFP Overstated by Birth/Death Model	Chart 4: Lasting Consumption Slowdown?

September Cut Base Case

The Fed’s more positive inflation outlook and greater concerns for employment suggest a risk management rate cut in September. The key variable will be the unemployment rate (i.e., the balance between labour demand and labour supply) rather than payrolls. Yesterday Powell said:

‘The main number you have to look at now is the unemployment rate because it’s true that the demand for workers in the form of payroll jobs, that number has come down, but so has the breakeven number, kind of in tandem.’

I think the size of the cut will depend on unemployment. If, between now and the 17 September FOMC, unemployment remains within the current range around 4.1%, my 25bp cut base case is likely. If unemployment moves clearly well above the range, for instance to 4.4%, a 50bp cut would be likely. By contrast, if unemployment was to fall through 4%, the Fed would probably not cut in September.

This assumes wage growth remains benign, there are no signs of inflation contagion from tariffed goods to non-tariffed goods and services, and long-term BEs remain stable, also my base case. If these conditions hold, a pickup in core PCE from the current 2.7% would not deter the Fed.

Market Consequences

Following the presser, market pricing of a September cut fell to 40% from 60% before. I think the market is confused in two respects.

First, it thinks the Fed is concerned about current price increases. As explained above, that is not the case. Current price increases are unavoidable given the size of tariff increases but Powell’s base case is that they will not become an inflation acceleration.

Second, market participants are likely overinterpreting Powell’s comments from yesterday.

‘We have made no decisions about September. We don’t – we don’t do that in advance. We’ll be taking that information into consideration and all of the other information we get as we make our decision at the September meeting.’

But these are only the current version of the ritual sentence, ‘We will continue to make our decisions meeting by meeting, based on the totality of the incoming data and their implications for the outlook for economic activity and inflation.’

The Fed has made it clear it is independent and that frees it to focus on managing the economy.

I still expect two-three 2025 cuts and at most one 2026 cut, against markets pricing 1.5 and three cuts, respectively.

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