Fed Expected To Cut Interest Rates, Though Inflation May Be Picking Up

Fixed income markets fully anticipate a September 17 FOMC rate cut, driven by recent labor market weakness, including July nonfarm payrolls of 73,000 and significant downward revisions for May/June to under 20,000. However, this comes amidst signs of accelerating inflation, with July PPI and CPI showing price increases and annual inflation near 3%, creating a complex policy dilemma for the FOMC. While a September cut appears probable, potentially bolstered by recent dissents and new appointments, the emerging trade-off between supporting employment and containing inflation could significantly complicate monetary policy decisions later in 2025.

Analysis

Fixed income markets are pricing in a high probability of a Federal Open Market Committee (FOMC) interest rate cut on September 17, driven by a marked deterioration in the labor market. The July Employment Situation Report showed a modest 73,000 nonfarm payrolls added, but more critically, figures for May and June were revised down to below 20,000 each—a stark contrast to the monthly average of over 100,000 in the preceding two years. This softening labor data, however, is emerging alongside signs of accelerating inflation, with both the Producer Price Index and Consumer Price Index for July indicating rising price pressures and annual inflation nearing 3%, above the FOMC's 2% target. This creates a significant policy trade-off, as the central bank must address a potential economic slowdown and rising inflation with a single policy lever. The case for a near-term cut is further supported by internal dovish pressure, evidenced by recent dissents from governors Waller and Bowman and the likely appointment of Stephen Miran. While a September cut appears likely, the conflicting economic signals suggest monetary policy could become significantly more constrained later in 2025 if stagflationary pressures persist.

Key Decisions for Investors

• Given that a September rate cut is heavily priced into fixed income markets, investors should monitor the upcoming August jobs report on September 5 for any data that could challenge this consensus and introduce near-term volatility.
• The emerging dynamic of a weakening labor market combined with accelerating inflation presents a complex macroeconomic risk; therefore, portfolio managers should evaluate their exposure to assets that perform poorly in stagflationary environments.
• While a September cut is probable, the inflation data creates significant uncertainty for the future path of rates, suggesting it is prudent to be cautious about extrapolating a prolonged easing cycle as the FOMC may be forced to halt cuts if inflation trends higher into 2025.