The Fed Will Cut Interest Rates In September? Don't Be So Sure

Financial markets are pricing an 86% probability of a 25 basis point Federal Reserve rate cut in September 2025, following hints from Jerome Powell. However, this expectation faces headwinds as the Fed's preferred inflation measure (PCE ex-food/energy) remains persistently above the 2% target, currently ranging 2.6-2.9% for 2025, even with tariff considerations. While the labor market remains solid with unemployment at 4.2%, the primary argument for a cut rests on economic forecasts anticipating a modest rise in joblessness. The Fed's long-term mandate emphasizes achieving low and stable inflation as crucial for sustainable labor market health, suggesting potential internal debate on the timing of any easing given current economic indicators.

Analysis

Financial markets are pricing an 86% probability of a 25 basis point Federal Reserve rate cut for the September 2025 meeting, creating a notable disconnect with underlying economic data. The primary obstacle to easing is persistent inflation, with the Fed's preferred metric, PCE excluding food and energy, remaining in a 2.6% to 2.9% range throughout 2025, stubbornly above the 2% target. While arguments exist to discount this figure for one-time tariff impacts, any calculation still confirms inflation is not yet controlled. Concurrently, the labor market remains robust and offers no justification for looser policy; the unemployment rate is stable at 4.2%, effectively at the Congressional Budget Office's estimated 4.3% natural rate, and layoff indicators are low. The argument for a September cut is therefore entirely forward-looking, predicated on the Fed's view that current rates are restrictive and on professional forecasts anticipating a modest rise in unemployment to 4.5% by mid-2026. This sets the stage for a significant internal debate at the FOMC, weighing the risk of acting pre-emptively against the mandate to ensure low and stable inflation, which the article notes is the long-term foundation for a healthy labor market.

Key Decisions for Investors

• Investors should recognize the significant risk of a hawkish surprise at the September meeting, as the market's 86% probability of a rate cut appears misaligned with persistent above-target inflation and a solid labor market.
• Focus should be placed on incoming PCE inflation and employment reports, as this hard data will likely supersede previous Fed guidance and will be the ultimate determinant of policy, potentially triggering a sharp repricing in fixed income and equities.
• Consider hedging against a 'higher-for-longer' interest rate scenario, as the economy's current resilience suggests it can withstand restrictive policy for longer than markets anticipate, warranting a review of duration risk in bond portfolios.