Might the Fed follow inflation's holding pattern?

We likely will have to wait for future historians to uncover exactly what was behind the Federal Reserve’s mid-September rate cut. Chair Powell cited the weakening labor market; others point to political pressure. While recent measures of employment certainly have softened, was it really weak enough to merit a move considering inflation has not retreated completely? Congress tasks the Fed with supporting both full employment and price stability, but the latter remains higher than its target of 2%. In fact, the Personal Consumption Expenditures Index (PCE), hardly budged last month. Year-over-year, it grew 2.7% in August, compared to 2.6% in July. Core PCE, which strips out volatile elements like food and gasoline, stayed at an elevated 2.9%. Of particular concern is that goods prices pulled back slightly. But that side of the inflation equation is likely to heat up if, as expected, businesses pass tariff-related costs onto consumers in the coming months. That could leave policymakers in a world of hurt.

Indeed, what if the labor market improves before the Fed’s October FOMC meeting? That’s a distinct possibility, as fewer people applied for unemployment pay in the week ended September 19, with jobless claims falling to 218,000. Combined with a significant upward revision of second quarter gross domestic product from 3.3% to 3.8%, the Fed might want to hold rates steady. That would fly in the face of market expectations that the reduction of the federal funds target range it issued in mid-September heralded the start of another string of rate cuts. This week’s nonfarm payrolls report will be as critical as it gets.