By Howard Schneider and Michael S. Derby
WASHINGTON (Reuters) -President Donald Trump may see lower Federal Reserve interest rates as a fix for two politically potent problems, the cost of servicing $36 trillion in government debt and the high cost of home ownership, but the path there may touch a third rail elected officials typically try to avoid – rising unemployment.
It is a dilemma tied to the fact that, so far, the rising import taxes and immigration crackdown imposed by Trump have been absorbed by the U.S. and global economies with less disruption than initially feared.
There is still a risk that inflation could rise even more than it already has and growth appears to be slowing. But talk of recession has diminished and the jobless rate has been steady at a level the Fed regards as full employment.
The situation, Fed Chair Jerome Powell said in a press conference on Wednesday, has left the central bank no compelling reason to lower interest rates until something changes. Given the price pressures still building in the economy because of tariffs, the betting among economists is that a further slowdown in growth – and a related rise in unemployment – will be the likely motivation for the policy-setting Federal Open Market Committee to finally change course.
“The implication of Powell’s remarks is that, if things continue to unfold as they have been – including, importantly, there being no deterioration in the labor market – the FOMC is very likely to stay on hold in September,” former Fed Governor Larry Meyer wrote after this week’s policy meeting concluded with the Fed’s benchmark interest rate left in the 4.25%-4.50% range. “At the same time, Powell sounded far from averse to cutting rates – as long as there’s a good reason to do so based on the evolution of the incoming data and outlook.”
Data on Thursday showed the measure the Fed uses to set its 2% inflation target ticked higher in June, with impacts from tariffs evident in several goods categories such as home furnishings and recreational equipment. The report from the Commerce Department also offered evidence that consumer spending, accounting for two-thirds of U.S. economic activity, was softening as the second quarter ended.
“The weak handoff means that spending growth in Q3 will most likely be weaker than in Q2,” Michael Pearce, deputy chief U.S. economist at Oxford Economics, wrote in a note. “That is especially true because we think the impact of tariffs on prices is still building, which will feed through to weaker growth in real disposable incomes.”
IMPACT OF TARIFFS
Powell told reporters repeatedly on Wednesday that he believes the best measure of the economy’s health right now is the unemployment rate, and Friday will bring the reading of that data for July. Powell noted that joblessness, which was 4.1% in June, has hardly changed over the last year, whereas inflation has moved a bit further from the Fed’s target, a dynamic he said the majority of his policymakers viewed as warranting no adjustment to interest rates.
It was not a unanimous view, however, as two Fed governors – Christopher Waller and Michelle Bowman, both Trump appointees – dissented from the majority, instead favoring a quarter-percentage-point rate cut.
Waller has argued previously that the tariffs are more likely to result in a one-time price increase, not persistent inflation, and are a bigger threat to demand. Both he and Bowman have said they believe the greater risk for the Fed to guard against now is a weakening job market.
Powell acknowledged that a one-time price increase was a reasonable base case and noted several times that there are “downside risks” for the job market. In addition to Friday’s nonfarm payrolls data, the Fed will get one more employment report – plus two months of inflation data – before its September 16-17 policy meeting.
The combination of Powell’s refusal on Wednesday to pre-commit to a September rate cut and Thursday’s higher-than-estimated inflation readings has clouded the outlook for when the rate cuts will resume. The Fed cut its policy rate three times in 2024, with the last move having occurred in December.
CME Group’s FedWatch tool now suggests the probability of a rate cut in September has dropped to just 39% from greater than 60% on Tuesday, before the Fed’s latest two-day meeting ended, and 75% a month ago.
“The above-target rise in core PCE (Personal Consumption Expenditures) prices in June, upward revisions to previous months’ data and the sharp rise in core goods inflation will do little to ease the Fed’s concerns about tariff-driven inflation,” said Harry Chambers, an assistant economist at Capital Economics. “If these pressures persist, as we expect, a September cut looks unlikely.”
David Mericle, chief U.S. economist at Goldman Sachs, however, sees a case remaining for a cut in September, although Powell’s comments on Wednesday indicate a reduction “is certainly up for debate.”
“We continue to see multiple paths to a possible September cut – underwhelming tariff effects, meaningful disinflationary offsets from other forces, and either genuine labor market softness or a scare from month-to-month volatility,” Mericle said.
(Reporting by Howard Schneider and Michael S. Derby; Editing by Paul Simao)
