The Fed is about to pick its battle

The Federal Reserve is widely expected to lower its target interest rate by 25 basis points at this week’s FOMC meeting, responding to increasingly clear signs of a softening labor market. While the forecasters are becoming more confident in the Fed’s next direction, there’s no guarantee it will be the right one.

US employment trends have been weakening. In addition to the weak August jobs report, initial jobless claims rose sharply in the Labor Day week, though that holiday might have created a seasonal distortion.

But the second component of the dual mandate, inflation, is still running hot. Last week’s record high in gold prices and elevated inflation expectations in the University of Michigan consumer sentiment survey suggest that many believe price pressure may be persistent. A continued period of elevated inflation and weak employment will create a challenging backdrop for the Fed. We look forward to hearing how Chair Powell intends to navigate these diverging trends.

Last week’s economic data reinforced the inflationary concerns. While the Consumer Price Index (CPI) generally fell in line with expectations, it remains outside the Fed’s target range of 2%. Headline CPI rose 0.4% in August from July, with the growth rate accelerating to 2.9% from July’s 2.7%. The increase was driven by food, shelter, and gasoline. Stripping out food and energy, core CPI increased 0.3% from July and remained at an annualized 3.1%.