What Will the Fed Do Under Pressure?

On Sept. 18, the Federal Reserve’s Federal Open Market Committee (FOMC) will make a highly anticipated decision on whether to cut interest rates for the first time since December. The market has put the chance of decrease in rates at about 90%. Will that be the right decision? Here are my thoughts.  

• The Fed has multiple mandates, among them achieving maximum employment and stable prices. Today, unemployment continues to be exceptionally low, but inflation remains above the Fed’s target. I believe this is unlikely to change dramatically prior to mid-September. To me, the best we can hope for coming out of the FOMC meeting is clarity on the Fed’s future direction of travel for interest-rate moves.
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• Since the FOMC meeting last month, we have seen data that job growth has slowed dramatically (primarily through significant revisions of past job growth), but job losses have been contained and employment stable. Going by these economic indicators, I think there’s an argument to be made that the Fed should stand pat on interest rates this time around.
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• Inflation pressures continue to grow, primarily through what I believe are likely to be one-time increases due to tariff pressures on goods. I’d argue if inflation moves higher, it will be driven by inflation from goods rather than services.
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• When the two mandates are in tension, the Fed has suggested it would consider how far the economy is from each goal, and the different time horizons over which those gaps are expected to close.
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• The Fed believes policy right now is modestly restrictive, a situation it believes appropriate given near maximum employment and somewhat elevated inflation.

So where does this leave the Fed? I—along with nearly everyone else—think the central bank is headed for a rate cut, but for me, the Fed should hold unless the situation changes dramatically over the next month and a half.  Tthe right thing for the Fed to do is wait and react to data rather than to predict where things head. I’m in the camp that central banks should cushion cycles, not create them.  

However, I recognize the world may not always work as I believe it should. There remains more inflation and jobs data to come, but without a significant shift in either, I think the Fed unfortunately will take cover and provide the market with a hawkish cut, signaling a slight move from a modestly restrictive to a neutral policy stance.

This is one of the rare instances I hope I am wrong.

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