Fed to Cut as Prices Rise and Economy Slows

The long-awaited resumption in the Fed’s interest rate cuts is likely to come this week, as the central bank grapples with a decelerating labor market and accelerating inflation. As a reminder, it was a year ago when the Fed started to cut rates after the pandemic-induced inflationary surge. At that time, the Fed said “in light of the progress on inflation and the balance of risks, the Committee decided to lower the target range for the federal funds rate by 1/2 percentage point to 4-3/4 to 5 percent.” They cut two more times in October and December 2024, by 0.25 percent each, leaving the Fed funds rate at today’s range of 4.25-4.5 percent.

Since that initial rate cut, there were two developments of note: Trump tariffs and immigration policies are filtering through the economy, pushing the inflation rate higher, and the post-pandemic hot labor market has cooled. The combination puts the Fed in a dicey situation, as it attempts to balance the risk of each side of its so-called “dual mandate”. Five years ago, Fed Chair Jerome Powell described the Fed’s job as “fostering as strong a labor market as possible for the benefit of all Americans,” while seeking “to achieve a 2 percent inflation rate over time.” Recent reports suggest that each side of that mandate is in trouble.

The labor market has slowed down over the past four months, but the deceleration was already in progress, according to the BLS Preliminary Annual revision to its data. The revision estimates how much the monthly payroll report overstated (or understated) actual job growth between April 2024 and March 2025 (the final estimate will be released in February 2026). The BLS said there were 911,000 fewer jobs than originally reported, which was the largest preliminary revision on record, back to 2000. That means that average monthly job growth for the period went from 147,000 to 71,000.

Concurrently, inflation has started to rise again. The Consumer Price Index (CPI) showed that overall prices increased by 2.9 percent from a year ago, the fastest rate since January, and core CPI, which strips out the volatile food and energy components, was up 3.1 percent annually, the strongest reading since February. Diane Swonk, Chief Economist at KPMG noted that “Some tariffs made their way into food prices. Food at home soared 0.5%, the hottest monthly increase since the height of pandemic inflation in June 2022.” And bad news for coffee lovers, prices surged by 3.6 percent in August alone, the fastest monthly pace since April 2011, and are up almost 21 percent from a year ago, “as the full effects of the 50% tariffs levied on Brazil last month work their way onto store shelves.”

“Typically, tariffs represent a one-time bump in price levels,” says Swonk, which is how the Fed is likely to justify a rate cut. But she notes that the Fed is also sensitive to the pain associated with “the blistering bout of inflation post-pandemic,” which caused many Americans to believe that “the economy was in a recession, even as job gains remained robust and unemployment fell.” That feeling was due to the fact that once people spent down their excess pandemic savings, they were faced with prices rising faster than their wages.

Also at this meeting, Fed officials will release their economic projections, which (SPOILER ALERT) are just that, projections, not certainties. Chair Powell will likely face a spicy press conference after the announcement, where he is likely to remind us that the Fed is data dependent.