FOMC Watch - Two-sided risk means there's no risk-free path
The FOMC lowered its policy rate to the 4.00-4.25% range. There was one dissent, with Stephen Miran favouring a half-point cut, and one 'silent' dissent, with a single dot showing no cuts this year, despite having the option to change that after. The monetary policy statement explicitly calls out the shift in the balance of risks - downside risks to employment have risen - as the reason for lowering the target range by 25 bps.
In their quarterly projections, FOMC members raised the median estimate for growth in 2025 from 1.4 to 1.6%, and from 1.6 to 1.8% in 2026. That suggests that there's slightly less of a concern about the impact from tariffs and reduced labour supply. While the unemployment forecast for 2025 remained the same, they see lower unemployment in 2026, down to 4.4% from 4.5% in the June SEP. Finally, they see more persistent inflation, with the same PCE projection for 2025, but a higher projection for 2026, now at 2.6% from 2.4% in June. They see the economy in a steady state, with 2% inflation and unemployment at its long-term level, by 2028. Overall, the decrease in unemployment and increase in inflation is perhaps somewhat at odds with the rate decision and change in dots described below, but alternatively, one can view the SEP as a reaction to today's rate cut.
The dot plot, which provides the members' most likely trajectory of the future policy rate, showed a dovish turn, with the median putting in two more cuts for the year, rather than two cuts total as in the June version. Nine out of nineteen members see at most one more cut, with six seeing no more cuts. Another nine see two more cuts, and Stephen Miran put in a ludicrous 3% for year end, likely his view on the neutral rate. The median for 2026 end-of-year did not move, implying only a single cut in 2026, although the distribution is wide. Eight members see a rate of 3.75% or 4%, with the remaining eleven spread out between 2.75 and 3.5%. Similar to the dot plot in June, the September dot plot remains very sensitive to the median shifting point. One person could have shifted the 2025 outlook from 3.75% to 4%, and one person could have shifted the 2026 outlook from 3.5 to 3.25%. We still largely see the two camps, which are now slightly less cleanly delineated amidst an overall dovish shift.
In his opening statement, Chair Powell characterized today's move as a shift to a more neutral policy stance. He noted that goods inflation is rising, but still saw mild services inflation. He sees changes in immigration as the primary culprit of the weakening labour market, and signalled that demand has come down a little more sharply than supply, with the unemployment rate going up.
The Q&A revealed more of the FOMC's thinking. Powell stated that they were able to deal with upside risks to inflation by keeping rates restrictive throughout the year, only because the labour market was strong. The risks were fully tilted towards inflation, whereas now they're going "towards equality," but are probably not quite there yet. They are moving in the direction of neutral and one should see today’s move as a risk management cut.
He characterized the labour market as clearly weakening, though not necessarily because of the large NFP revision, which he described as 'mostly predictable.' It is more about unemployment ticking outside its 4.1-4.2% range of the past year, and seeing weakening at the fringes of the labour market. Minority and low income unemployment is up, participation is down, and part of that is cyclical. There's common consensus on the FOMC that some of the downside risk they've talked about over the past year has now been realized. That is why there were no upside dissenters.
Still, there are two mandates and they have to keep an eye on inflation. Powell commented on the clear signs of tariffs in goods inflation, but that the majority of tariffs are currently being paid by US companies, not exporters, nor consumers. He sees about a 0.3-0.4pp contributed to core PCE inflation. He was not yet worried about the services inflation that we've signalled in recent months. Instead, he actually suggested upside risks to inflation have decreased because of the weakening labour market, which appears to be consensus based on the SEP.
On some recent positive signals of the economy picking up again in Q3, Powell noted that he'd love to see those upside risks to the economy happening. Overall, the unemployment rate is low at 4.3%, the economy is growing at 1.5%. He does not see a weak economy, just a hard one to set policy for. Would cutting rates by 25bps now really stimulate the economy? Powell pointed to markets pricing in a full rate path doing some of the work, while explicitly not necessarily blessing what they're pricing. One almost got the sense that he saw it as convenient at this particular juncture.
As we stated in our preview, the economy can handle this 25 bps cut, and it will not immediately lead to inflation reigniting. It leaves the Fed somewhat better positioned in case the slowdown in the labour market persists or deteriorates. More rapid easing would likely turn upside risks to inflation to reality, and perhaps keeping a foot on the break will lead to unemployment rising substantially. We still see the upcoming meetings as undecided, and expect that a pickup in inflation, and only mild deterioration in the labour market will prevent further cuts in the remainder of the year.