The Federal Open Market Committee’s policy decision this week will not be about a potential rate cut.
The federal funds rate will remain in a range between 4.25% and 4.5% and we do not expect Federal Reserve Chairman Jerome Powell to imply that a September rate cut is in the cards either.
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Rather, we expect Powell’s news conference on Wednesday to revolve around what we think will be two dissents from two members of the Board of Governors, Michelle Bowman and Christopher Waller.
A credible case could be made for a rate cut. After all, private sector hiring has slowed to an average of 107,000 over the past six months, which is barely sufficient to keep labor conditions stable and has in turn resulted in slowing personal consumption.
The remainder of the committee is not convinced that the Fed should resume cutting rates toward its 3% terminal target. Those members will point to uncertainty around trade policy as well as inflation pressures caused by tariffs, expansionary fiscal policies and accommodative financial conditions.
Our estimation of the Federal Reserve’s reaction function implies an optimal policy rate of 4.65%, which is in line with current policy. That rate strongly suggests no policy accommodation is necessary.
In addition, should the personal consumption expenditures index, the Fed’s preferred measure of inflation, increase when the PCE data is released on Thursday, the optimal policy rate will move higher, undercutting arguments for a rate cut.
This is why our forecast of the monetary policy path has only one 25 basis-point rate cut this year, in December.
At the end of the day, Bowman and Waller may dissent, but their views are likely to fall on deaf ears on the committee.
Over the next few months, the FOMC will most likely observe an acceleration in tariff-induced inflation to 3% or higher amid an economy slowing toward 1% growth and job creation declining to around 100,000 per month.
And that reflects our baseline forecast for the second half of the year of stagflation lite.
