On July 28, Reuters reported that the U.S. central bank is likely to keep interest rates unchanged during an upcoming policy meeting. This decision comes despite pressure from President Donald Trump, who has expressed his frustration over the Fed's reluctance to cut rates. However, the meeting may not be without contention, as it is anticipated that one or two Federal Reserve governors could dissent in favor of lower borrowing costs.
The prevailing sentiment among the majority of Fed policymakers is one of caution. They remain concerned that the tariffs imposed by Trump could hinder progress in bringing inflation back to the Fed's target of 2%. Currently, these inflation concerns outweigh any immediate worries regarding the state of the labor market.
Recent trade agreements, including a deal between the U.S. and Japan, which sets tariffs at 15%, could imply that overall import duties may remain significantly lower than the levels announced by Trump on April 2 during his "Liberation Day" speech. Despite these developments, it is noteworthy that U.S. tariffs are currently at their highest level in 90 years. The repercussions of these tariffs are becoming evident, particularly in household spending, with rising prices for goods such as furnishings and apparel contributing to an annualized consumer inflation rate of 3.5% as of June.
Federal Reserve Chair Jerome Powell has acknowledged the potential for these rising prices to unsettle households, possibly triggering a broader inflationary spiral. He argues that the Fed should exercise patience and gather more data before making any adjustments to interest rates, especially given the current unemployment rate of 4.1%, which is close to estimates of full employment.
The differing opinions among Fed officials reflect varying perspectives on the impact of Trump's broader economic policies, which include tax cuts and deregulation. Analysts from Nomura Securities predict a rare dissent from both Fed Governor Christopher Waller and Fed Vice Chair of Supervision Michelle Bowman, who are expected to advocate for a 25-basis-point rate cut. This would mark the first double dissent from Fed governors since 1993.
Waller, who has been mentioned as a potential successor to Powell, has voiced concerns about the slowing growth of private-sector jobs, suggesting that without easier credit conditions, companies may resort to layoffs. Meanwhile, Bowman shares similar worries about the labor market and believes that a rate cut could be necessary to avert further deterioration.
As the Federal Reserve prepares to release its policy statement, the Commerce Department is anticipated to report a reacceleration of economic activity in the second quarter, pushing total output above $30 trillion in non-inflation-adjusted terms for the first time. While this data may bolster Trump's claims about a booming economy, central bankers view the situation as more complex.
Despite a drop in GDP in the first quarter due to a rush to front-run tariffs, a significant reversal in imports is expected to boost Q2 GDP. However, ongoing tariff-induced cost pressures, persistent policy uncertainty, and elevated interest rates are dampening employment growth, business investment, and household consumption, according to Gregory Daco, chief economist at EY-Parthenon.
Consumer spending, which constitutes two-thirds of economic output, has shown resilience, with retail sales exceeding expectations last month. Although household bank account balances have decreased year-over-year, data from the JPMorgan Chase Institute indicates that overall cash reserves are in a healthier state. Furthermore, bank credit extended to consumers and businesses has increased for the first time in over two years, indicating a potential uptick in economic activity.
Manufacturing output also recorded growth last quarter, albeit at a slower annualized pace compared to earlier in the year. However, business investment appears to be weakening, as evidenced by a decline in non-defense capital goods orders in June. Employment growth has also slowed, and the housing market faces significant challenges, with construction spending down for nine consecutive months—a trend not seen since the financial crisis.
With factors such as high mortgage rates and declining housing demand, economists at Citi suggest that these trends indicate that current interest rates are still restrictive. The uncertainty surrounding the labor market and broader economic conditions continues to weigh on consumer demand.
As the Federal Reserve navigates a complex economic landscape, the decision to maintain interest rates may reflect a cautious approach in response to persistent inflationary pressures and an uncertain labor market. The upcoming policy meeting will be closely watched, not only for its immediate implications on borrowing costs but also for the broader signals it sends regarding the U.S. economy's trajectory.
