The Fed’s Relentless Rate Cut Pressure

Trump’s pressure for a rate cut from the Federal Reserve is growing. Treasury Secretary Scott Bessent said in a TV interview last week, “If you look at any model for the Fed Funds rate, it suggests that we should probably be 150, 175 basis points lower.”

Stephen Miran, who is Trump’s pick to fill a temporary opening on the Fed’s Board of Governors, argued in a CNBC interview that inflation is well-behaved. Miran, who is a strong supporter of Trump’s reciprocal tariffs, highlighted a new White House report that shows prices of imported goods had fallen between December 2024 and May 2025, though reciprocal tariffs were only announced in April.
 

Then, the WSJ reported the Trump Administration revealed that the list of candidates for Fed Chair would be expanding: “The hope is that a greater number of surrogates will take to the airwaves and publicly pressure the Fed to lower rates.”

The clincher was the July CPI report. Headline CPI came in a hair under expectations, and core CPI was a hair above expectations. The report set a risk-on stampede in the stock market in anticipation of a September rate cut, though the bond market reaction was far more cautious. In the end, the consensus view settled at a virtual certainty of a quarter-rate point cut at the September FOMC meeting, and a total of two cuts in 2025.

 

 

A Not-So-Tame CPI

Beneath the surface, however, CPI inflation wasn’t as tame as the stock market’s initial interpretation. The good news is core goods CPI rose, but not as much as projected from tariff effects. But core services ex-housing, otherwise known as “supercore services” monitored by Powell., rose. The main factor depressing core CPI has been housing, which is lagging.

Other inflation indicators like core sticky price CPI also continued to trend upward.

 

Tariff-related price increases are making their presence felt, according to MarketWatch:

Still, a team of Barclays fixed-income researchers revealed that while the U.S. collected $108 billion in tariffs this year as of June, over half of all imports into the U.S. still entered duty-free because of things like trade diversions, item-specific exemptions and reclassifications, which resulted in an effective tariff rate of “just” 10%.
 

“The finding that effective tariff rates have increased less than anticipated may help explain the relatively benign economic impact observed thus far,” the Barclays researchers, led by Mark Cus Babic, wrote in a Friday client note.
As a baseline, the Barclays team foresees an ultimate U.S. baseline tariff rate of 15% taking effect in the third quarter, with risks skewed to the upside. They also warned of a likely intensified “drag” on economic growth, especially if U.S. authorities or other countries start cracking down on trade diversions or start removing certain tariff exemptions.

Goldman’s preliminary analysis of PCE inflation in June estimated that foreign exporters absorbed 14% of the tariffs, U.S. companies 64% and consumers 22%. Goldman expects that tariffs will increase core PCE by 0.66% by the end of 2025 and slowly decrease over time.
 

 

The equity rally began last Tuesday in the wake of the CPI report, but ended on Thursday when the PPI report came in well above consensus. Core PPI rose 0.9% compared to expectations of 0.2%. Even though much of the increase was attributable to airfares and portfolio management fees, which are unrelated to tariffs, PPI ex-food, energy and trade services came in hot at 0.6%. The jump in PPI is a signal that foreigners aren’t absorbing the tariff increases, which implies a hotter-than-expected July PCE reading.
 

Now that July CPI and PPI are known, PCE can be estimated with a high degree of accuracy. The Wall Street consensus for July core PCE is just under 0.3%, which represents an accelerating trend.
 

 

The dynamic of moderate goods inflation and a revival in services inflation is evident in both the CPI and PPI reports, and contrary to the FOMC doves’ narrative of transitory tariff-related inflation.
The market continues to believe a September rate cut is a virtual certainty. The bond market’s reaction wasn’t as enthusiastic. Inflation expectations, as measured by TIPs to long-dated zero-coupon Treasuries, rose. The long-end of the yield curve, as measured by the 30-10-year yield spread, steepened. The USD weakened.
 

 

 

Jackson Hole Smoke Signals

Could a September rate cut be justified because of weakening labour market conditions?

Watch for the signals of policy discussion direction at the Fed’s Jackson Hole symposium. While the extremely large downward revisions in nonfarm payroll underscore labour market weakness, the policy discussion could turn to whether weak jobs growth is mainly attributable to supply or demand factors. A rate cut will do nothing to raise the labour supply, but it will boost labour demand.

I have also pointed out an anomaly in the high frequency data. Initial jobless claims (red lines, inverted scale) have been remarkably low in the past few weeks, indicating a low firing  economy. Is this a forecast of better jobs growth (blue line) in the coming months.

 

There are other signals which could be of significance that emerge from Jackson Hole.

• The price stability and full employment mandates are currently in tension with each other. As inflation is falling but progress toward the 2% target is stalled, but employment is weak, which way will the Powell speech lean?
• Will the Fed move away from Flexible Average Inflation Targeting (FAIT), a policy that began when inflation was below target, to a simple 2% target? Such a pivot would have hawkish implications for monetary policy.

The FOMC consensus is becoming bifurcated. The dovish tilts of Fed Governor Christopher Waller and Michell Bowman are well-known. In addition, San Francisco Fed President Mary Daly (non-voter) signaled she would likely favour a rate cut. On the other hand, Chicago Fed President Austan Goolsbee (voter) called for caution and highlighted the jump in services CPI as concerning. Kansas City Fed President Jeff Schmid (voter) also made the case for waiting: “I see no possibility that we will know the effect of the tariffs on prices, either as a one-off shock to the price level or a persistent inflation impetus, over the next few months…With the economy still showing momentum, growing business optimism, and inflation still stuck above our objective, retaining a modestly restrictive monetary policy stance remains appropriate for the time being.”

A September rate cut is in play, but it’s not a certainty. I believe market expectations are overly dovish.