Stagflation Risks and the Fed: What to Expect at the September Meeting
At its meeting on July 29-30, the Federal Reserve (the “Fed”) opted to keep the federal funds rate unchanged at 4.25–4.5%. Currently, market consensus strongly anticipates that the September meeting will mark the first rate cut since December 2024. [1] Beyond this expectation, clarity diminishes for observers.
The economic data have rarely been more challenging to interpret, and the widening division between policymakers and the executive branch is compounding the uncertainty. In this article, we aim to unpack these developments.
The July Meeting
A defining feature of the July decision was the growing division among Fed officials regarding the appropriate path forward. For the first time since 1993, two governors – Michelle Bowman and Christopher Waller – dissented, advocating for an immediate 25 basis point cut.[2]
The minutes of the meeting further highlighted that there was no broad consensus on the relative importance of risks to employment and risks to inflation.[3] This uncertainty was later reflected in Chairman Jerome Powell’s speech at the Jackson Hole symposium (covered in full here), which underscored the fragility of the current equilibrium.[4]
Confounding Data
In the eight weeks following the last committee meeting, two key reports on employment and inflation were released, providing insight into whether stagflation might be emerging.
July saw the addition of only 73,000 jobs, with May and June figures sharply revised downward to 19,000 and 14,000, respectively.[5] By comparison, monthly job gains averaged roughly 167,000 in 2024 and 216,000 in 2023,[6] indicating a softening labor market.
This was followed by July’s Consumer Price Index (CPI) data. Headline CPI held steady at 2.7% year-over-year, while Core CPI rose from 2.9% to 3.1%,[7] both clearly above the 2.0% target.
Similarly, the recently released Personal Consumption Expenditures (PCE) figures showed headline PCE at 2.6%, while Core PCE (excluding food and energy) inched up to 2.9%, its highest level since February but in line with expectations.[8]
Meanwhile, Q2 GDP growth was strong at 3.3%,[9] recovering from the negative growth in Q1, supported by robust consumer spending. Full-year GDP forecasts, however, suggest weaker growth relative to 2024,[10] potentially supporting arguments for rate cuts to stimulate the economy. The continued uncertainty regarding the impact of tariffs, and their persistence, warrants caution in interpreting these forecasts.
Increasing Discord
Beyond the mixed data, the intensity of differing opinions within the Fed is rising. Chairman Powell continues to maintain a neutral stance, albeit slightly favoring the dovish camp, while other Fed officials have become more outspoken.
At Jackson Hole, Kansas City Fed President Jeffrey Schmid [11] and Cleveland Fed President Beth Hammack [12] conveyed to the press that current data do not yet justify rate cuts. In contrast, Trump appointee Christopher Waller, in his August 28th speech titled “Let’s Get On With It”, emphasized the urgency of action to prevent further labor market deterioration.[13]
Conclusion
Given the disorder and uncertainty, market participants face two choices. One is to engage in speculative attempts to predict upcoming data or political developments. The other is to deliberately focus on the longer-term perspective, avoiding the distracting noise of short-term events.
The latest Fed minutes indicate that several participants believe the current interest rate level is not far above the neutral rate[14] - the inflation-adjusted short-term rate consistent with stable inflation and the economy operating at potential, i.e., neither stimulating nor restraining growth. This supports the view that rates are unlikely to return to the low levels seen over the past decade. Transitioning to a “higher-for-longer” interest rate environment is a significant development, as it fundamentally alters the dynamics of investing and the economy itself. Since this is a gradual process rather than a one-time change, there is no need for panic or rash decisions, despite potentially turbulent market sentiment.
[5] U.S. Bureau of Labor Statistics
[6] Federal Reserve Bank of St. Louis
[7] U.S. Bureau of Labor Statistics