Weekly Economic Trends and Indicators

The Headlines:

Last Wednesday, the Federal Open Market Committee (FOMC) of the Federal Reserve voted to decrease the target range for the federal funds rate by ½ percentage point to 4 to 4.25%. This was the first rate cut of 2025 after holding rates steady since late last year. This move was highly anticipated, though opinions differed as to whether the move was necessary or whether an even larger cut is needed now.

The Details:

For most of the last year, the Fed has been cautious about further interest rate cuts because the inflationary effects of the recently imposed tariffs are not yet fully known. However, the economy, particularly the labor market, has continued to gradually slow down. With the inflation and labor market risks roughly in balance, interest rates were stuck in a holding pattern. In recent days, especially after the large negative revisions to payroll employment, the balance of risks shifted. As Federal Reserve Board Chair Jerome Powell put it in the press conference,

In the near term, risks to inflation are tilted to the upside and risks to employment to the downside—a challenging situation. When our goals are in tension like this, our framework calls for us to balance both sides of our dual mandate. With downside risks to employment having increased, the balance of risks has shifted. Accordingly, we judged it appropriate at this meeting to take another step toward a more neutral policy stance.

The Context:

The term “balance of risks” is frequently used by the Fed to refer to the tension between concerns about inflation and the labor market. Often, these risks move inversely. When economic growth is picking up, the labor market is healthy, but there is upward pressure on inflation. When hiring slows, it is typically associated with lower demand and lower inflation.

However, this year inflation has remained stubbornly high even as the labor market started to slow down. This is the “tension” to which Powell referred. Making matters worse, the effect of tariffs on inflation is difficult to predict. Easing monetary policy right before the tariffs start to impact consumer prices could result in a sudden—even if temporary—spike in inflation. Waiting too long to cut rates could allow the labor market to slow down enough to cause a recession.

Was it the right move at the right time? The first place to look is the bond market. Under normal circumstances, the 10-year bond yield tends to move in the same direction as the Fed, but usually by a smaller amount. This time, the 10-year yield has been trending down most of the year anticipating lower inflation and an eventual move by the Fed. However, the yield jumped back up by about 10 basis points, suggesting at least some discomfort with the possibility of more aggressive cuts in the future.

While the rate cut provides some relief to consumers and businesses, the Fed will have to do more than simply meet market expectations to reverse the trends in the labor market. In the meantime, we could see higher inflation expectations until we see how much tariffs will affect prices going into next year.

Next week: Inflation update