The outlook for the Federal Reserve’s September interest-rate decision has changed significantly in recent weeks. Earlier in the year, investors had expected the Fed to gradually lower interest rates as inflation cooled and the labor market showed signs of slowing. However, recent comments from Fed Chair Kevin Warsh have shifted expectations in the opposite direction. Towards the end of August, financial markets were pricing in roughly a 60% probability of a rate increase in September, making a rate cut considerably less likely.
Why a Cut Could Still Be Considered
The strongest argument for a rate cut is the condition of the labor market. Employment growth has weakened, and July saw an unexpected decline in jobs. Economists are expecting another relatively modest employment gain for August, which could provide the Fed with a reason to be cautious about keeping monetary policy too restrictive. If the upcoming employment report shows further deterioration, the case for supporting economic activity through lower rates would become stronger.
Economic growth is another consideration. The Fed has to balance its two mandates of price stability and maximum employment. If evidence accumulates that businesses are reducing hiring, consumers are becoming more cautious, or economic growth is losing momentum, policymakers may become more comfortable with lower interest rates. A September cut, however, would likely require a meaningful change in the economic data between now and the meeting.
Why a Cut Appears Unlikely
Inflation remains the primary obstacle. Fed Chair Warsh emphasized at the Jackson Hole economic symposium that inflation is still too high and that policymakers need clearer evidence that it is moving toward the Fed’s 2% objective. His comments were interpreted as relatively hawkish and prompted a sharp increase in market expectations for a September rate increase.
Energy prices also complicate the picture. Recent geopolitical developments have pushed oil prices higher, creating the possibility of renewed inflationary pressure. Higher energy costs can eventually feed into transportation, goods and services, making it more difficult for the Fed to conclude that inflation is moving sustainably toward its target.
The Fed also has to consider its credibility. Cutting rates while inflation remains elevated could risk slowing the progress made toward price stability. Conversely, raising rates when employment is weakening could put additional pressure on the economy. That leaves policymakers with a difficult balancing act heading into the September meeting.
What to Watch
The first couple of weeks in September will be particularly important. The August employment report and August inflation data, scheduled ahead of the Fed’s September 15– 16 meeting, could materially change expectations. A surprisingly weak labor report combined with softer inflation could reopen the door to a rate cut. Stronger employment or persistent inflation would make a cut much harder to justify and could reinforce expectations for either no change or another increase.
While a September rate cut was once viewed as a reasonable possibility, the latest information has moved the outlook substantially. At this point, a rate cut appears unlikely, with the greater debate being whether the Fed holds rates steady or raises them. The decision will ultimately depend on the economic data available immediately before the meeting, rather than on a predetermined path.