The Federal Reserve is caught in a tough spot. In August, core inflation jumped to a multi-month high of 3.1% y-o-y. This spike in inflation calls into question the timing and depth of any future interest rate cuts. Even leading economists have suggested that inflation will start to moderate by the end of next year. The drag of higher tariffs and a booming economy continue to make a recession a serious risk. The Fed’s leadership, particularly Chair Jerome Powell, is under mounting pressure. It’s pressure from financial markets and politicians that are forcing them to act boldly.
At 3.8% most recent data shows services inflation clearly above the inflation target of the Federal Reserve. Meanwhile, the producer price index has fallen, an indication of a potentially more concerning trend. This drop provides us with a confusing picture of our economy as a whole. In addition, July’s inflation numbers were revised down, making it more difficult for the Fed to make a prudent decision going forward.
Economic Factors Contributing to Inflation Risks
This unique and fraught economic environment poses numerous challenges to the Fed. The truth is that higher tariffs on imports have pushed up goods prices directly. These tariffs have secondary effects that are adding to inflation even more. These tariffs have been shown to drive up costs for American businesses that usually pass on those higher costs to American consumers.
Furthermore, a strong economy, supported by expansionary fiscal policies, can serve to amplify the inflation. If consumers keep spending at high levels and businesses keep investing, demand will exceed supply, creating upward pressure on prices. These factors compound each other in complex ways. The Federal Reserve needs to deftly balance these to keep a healthy economy for long-haul and ultimately win at controlling inflation.
As core price increases start to cool, that could mean the bill from the tariff tantrum may not be as severe as it first appeared. Doubts still linger. The Fed should take all of these factors into consideration as it decides what to do next.
Powell’s Cautious Approach and Political Pressures
Chair Jerome Powell has been clear on this, repeatedly warning against easing monetary policy on the cheap. It’s understandable that he’d be cautious. He should want to avoid causing a potential economy-booming-overheating. He surely wants to get inflation back down to target. Powell is acutely aware of the criticism that could arise if the Fed were to cut rates prematurely, particularly in light of the persistently high services inflation.
Partisan political pressures double down on Powell’s already complicated calculus. Former President Donald Trump has been vocal in calling for 300 basis points of immediate rate cuts, arguing that such measures are necessary to support economic growth. A 50 basis point cut would be the clearest signal yet that Powell has waited too long to act. This should cause the public to wonder about the Fed’s credibility behind this move.
Financial markets are guessing on three such cuts of 25-basis points by year’s end. Such an expectation would mean a move in the direction of a more accommodative monetary policy. Powell will show that he is not closed to the idea of more cuts. At the same time, he will likely stress that caution is needed given persistently high inflation.
Future Outlook and Potential Dissent
Though uncertain, the Federal Reserve’s decisions will likely continue to spark debate among policymakers as they chart a course through these troubled economic waters. Some members may advocate for aggressive rate cuts in response to rising inflationary pressures, while others may argue for maintaining a more conservative stance to avoid exacerbating the situation.
Powell has definitely been preparing the markets for future meetings. He will almost certainly talk about his commitment to the war on inflation while remaining flexible to new data as it comes into play. The contradictory signals from recent data highlight the challenge in developing any consistent policy approach in such an uncertain environment.