Key Takeaways
- A relatively tame inflation report Tuesday boosted investors’ hopes that the Federal Reserve will lower interest rates in September.
- Fed officials have kept rates high out of concern that President Donald Trump’s wide-ranging tariffs will ignite inflation.
- With inflation not rising faster than expected, Fed officials may turn their attention to boosting the job market, which has lost steam in the past three months at least partly due to tariffs.
- Lower interest rates could boost the economy and encourage job creation, but may risk worsening inflation.
With the job market faltering and consumer prices growing less than expected, investors are increasingly betting the Federal Reserve is about to cut interest rates to boost the economy.
The governments official report on July inflation didnt deliver any nasty surprises when released Tuesday morning. That led traders to price in higher chances that the Federal Reserve will start rolling back its anti-inflation interest rate hikes when its policy committee next meets in September.
After the report, there was a 94.1% chance the Fed would cut its interest rate by a quarter-point in September, up from an 85.9% the day before, according to the CME Group’s FedWatch tool, which forecasts rate movements based on fed funds futures trading data.
Fed officials are balancing the central banks dual mandate of keeping inflation in check while keeping employment high. The most recent round of economic data has shown the most red flags on the employment side of that mandate. Job growth has slowed to a crawl over the last three months, while core inflation has remained above the Feds goal of a 2% annual rate, but hasnt accelerated alarmingly fast.
The Feds remedy for an economic slowdown is lower interest rates, which encourage borrowing and spending and, in turn, businesses to hire more workers. Thats the opposite of its playbook for defeating inflation, which is higher rates to slow the economy and bring supply and demand back into balance.
Despite the increase in core inflation, we expect the Fed to cut rates next month as they pay closer attention to the weakening labor market, Jeffrey Roach, chief economist for LPL Financial, wrote in a commentary.
Interest Rate Roller Coaster
Fed officials use monetary policy to influence the economy by manipulating the federal funds rate. The rate, which dictates the interest rate at which banks can borrow money, affects interest rates for all kinds of short-term loans.
In March 2020, the Fed chopped the fed funds rate to near-zero to boost the economy with easy money. Then, when inflation flared in 2022, the Fed ratcheted up interest rates to a two-decade high to counteract the price increases.
Fed officials began cutting rates in late 2024 as inflation fell toward the 2% goal, most recently cutting in December. Since then, central bankers have held off on further rate cuts, keeping the rate in a range of 4.25% to 4.5%, out of concern that President Donald Trumps wide-ranging campaign of tariffs will set off a fresh round of inflation.
Trump has increasingly pressured the Fed to cut rates, lobbing insults and threats at Fed Chair Jerome Powell in recent months. Although Powell is one of 12 votes on the Federal Open Market Committee, the Fed chair is influential in its decisions. Trump appointed Powell in 2018, and former President Joe Biden gave him a second four-year term in 2022.
Trump has repeatedly demanded the Fed cut rates, arguing high interest rates are costing the government too much in interest payments on the national debt. Powell has resisted the pressure, saying the Fed should only make decisions based on its economic policy goals and should remain independent of political pressure.
Trump turned up that pressure Tuesday in a social media post threatening to investigate Powell over alleged cost overruns in an ongoing renovation project at the Feds headquarters.
The damage he has done by always being Too Late is incalculable, Trump posted. Fortunately, the economy is sooo good that we’ve blown through Powell and the complacent Board. I am, though, considering allowing a major lawsuit against Powell to proceed because of the horrible, and grossly incompetent, job he has done in managing the construction of the Fed Buildings.
The Fed’s Choice: Fight Inflation, Or Boost Jobs?
Fed officials now face a dilemma. Key inflation indicators remain over 2% and are heading in the wrong direction, though not as quickly as some forecasters had feared. Meanwhile, the tariffs have disrupted job creation, stoking concerns about a possible recession and mass layoffs.
Fed policy can only address one of those problems at a time, at the risk of making the other worse.
Whether the Fed keeps the rate steady to control inflation, or cuts it to boost the job market, could hinge on next month’s round of economic data. Federal Open Market Committee officials will receive one more round of labor market and inflation reports before making their next decision.
“For the Federal Reserve, inflation is much further from its target than the unemployment rate, which is why we expect them to hold off rate cuts another few months,” Michael Pearce, deputy chief U.S. economist at Oxford Economics, wrote in a commentary. “However, another weak set of jobs data in August would force their hand early.”
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