The US Federal Reserve is positioning itself for an interest rate cut in September, though it’s not a sure thing. At its latest meeting, the central bank kept the federal-funds rate unchanged at 4.25%-4.50%. But unlike at the last several meetings, this was not a unanimous decision. Two of the 12 Federal Open Market Committee members voted to cut rates by 0.25 percentage points.
Additionally, language in the first paragraph of the Fed’s official press release was revised from “economic activity has continued to expand at a solid pace” at the last meeting to “growth of economic activity moderated in the first half of the year.” This is an accurate characterization, in our view. Real gross domestic product growth averaged 1.2% quarter over quarter in the first half of 2025, a markedly lower pace than the 2.7% averaged over 2022-24. Meanwhile, we didn’t see any revision in language that suggested a heightened assessment of inflation risk.
The dissenting votes and the press release both strongly suggest the Fed will cut rates in September. Further evidence comes from the fact that the June FOMC projections called for a total of two rate cuts in the remainder of 2025, and there are only three meetings left in the year. But futures markets currently only imply about a 40% probability of a cut. We’d say the probability is a bit higher at around two-thirds, but still not a shoo-in.
Powell Sounding Hawkish on Interest Rates
One factor weighing against the odds of a September cut is that the tenor of Chair Jerome Powell’s press conference remarks were more hawkish than the official press release. Powell said the committee has “made no decisions about September”—the usual language for him. But when pressed, he was keen to emphasize the ongoing inflation risks while minimizing the downside risks for economic growth and the labor market.
Powell noted that inflation is still elevated. Core PCE inflation is likely to post at 2.8% year over year as of June 2025, showing no improvement versus the 2024 average of 2.8%. Core goods inflation is starting to increase, probably due partly to tariffs. And Powell commented that it’s “still quite early days” in terms of tariffs’ impact on inflation. He said US companies are currently paying most of the tariff bill, but they indicate in surveys that they plan on passing most of those costs to consumers via price increases, which concurs with our analysis.
While we think inflation is likely to move moderately higher over the next year or so, we are still worried about downside risks to economic growth and the labor market, which Powell downplayed to some extent today. He noted that if risks to inflation and growth/the labor market were in balance, it would be appropriate to reduce rates from their “moderately restrictive” level.
The current rate range of 4.25%-4.50% is markedly higher than the prepandemic (2017-19) average of 1.7%. Most economists see the neutral rate as significantly lower than current rates, albeit not as low as the prepandemic average. The FOMC’s long-run expectation for the federal-funds rate is 3.0%.
Two signals that interest rates may need to move closer to neutral levels are the deceleration in consumer expenditure growth and the cooling in the housing markets. Powell downplayed the deceleration in GDP growth in the first half of 2025, pointing to the stability of the labor market. But labor market conditions are a lagging function of economic growth, so the Fed must target stability in the latter to assure the “maximum sustainable employment” part of its dual mandate.
We suspect Powell may be on the hawkish side of the committee vis-à-vis a September rate cut, in which case we shouldn’t take his sentiments today as definitive. We still think it’s very likely the Fed will cut twice this year (first in September), in line with the FOMC June projections.
