Fed may cut 50 bps in H2CY25, but may be on hold in 2026
·
As per the Fed’s modified strategy document and
Powell’s Jackson Hole speech, the Fed may now adopt flexible inflation and
employment targets
·
In the longer run, the Fed will target 2.0% inflation
and a below 4.0% (~3.5%) unemployment rate
·
But in the short/midterm, the Fed may target 2-3%
core inflation and 3.5-4.5% or 4.0-5.0% unemployment rate as per
underlying/evolving economic scenarios
·
Fed may keep 3.0% longer run terminal/neutral rate
against 2.5% in the pre-COVID era
·
Fed may keep 1.00% real rate (3.0% terminal rate –
2.0% core CPI inflation) against 0.50% in the pre-COVID era
·
Fed may be anticipating 3.5% average core CPI
inflation in 2026 from 3.0% in 2025 due to Trump’s policies
On
Friday, August 22, 2025, all focus of the market was on Fed Chair Powell’s
speech at the annual symposium at Jackson Hole. Wall Street Futures, Gold, and UST soared, while USD plunged after
Powell indicated an imminent policy shift. Powell signalled 50 bps cumulative
rate cuts in H2CY25 (September and December), but another 50 bps rate cuts in
2026 may not be a done deal yet as the Fed is worried about Trumpflation and
core CPI may surge to 3.5% in 2026 from a 3.0% average in 2025. Powell
basically acknowledged the risk of both higher unemployment and higher
inflation in 2026. Powell said:
·
Over the course of this year, the U.S.
economy has shown resilience in a context of sweeping changes in economic
policy. In terms of the Fed's dual-mandate goals, the labor market remains near
maximum employment, and inflation, though still somewhat elevated, has come
down a great deal from its post-pandemic highs. At the same time, the balance of risks appears to be shifting.
·
Putting the pieces together, what are the implications
for monetary policy? 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. Our
policy rate is now 100 basis points closer to neutral than it was a year ago,
and the stability of the unemployment rate and other labor market measures
allows us to proceed carefully as we consider changes to our policy stance. Nonetheless, with policy in a restrictive
territory, the baseline outlook and the shifting balance of risks may warrant
adjusting our policy stance.
On August
22, Powell/Fed/FOMC also released the Fed’s updated longer-run goals and
monetary policy strategy:
“In
my remarks today, I will first address the current economic situation and the
near-term outlook for monetary policy. I will then turn to the results of our
second public review of our monetary policy framework, as captured in the
revised Statement on Longer-Run Goals and Monetary Policy Strategy that we
released today-----
Evolution
of Monetary Policy Framework
Turning to my second topic, our monetary policy
framework is built on the unchanging foundation of our mandate from Congress to
foster maximum employment and stable prices for the American people. We remain
fully committed to fulfilling our statutory mandate, and the revisions to our
framework will support that mission across a broad range of economic
conditions. Our revised Statement on Longer-Run Goals and Monetary Policy
Strategy, which we refer to as our consensus statement, describes how we pursue
our dual-mandate goals. It is designed to give the public a clear sense of how
we think about monetary policy, and that understanding is important both for
transparency and accountability, and for making monetary policy more effective.
The changes we made in this review are a natural
progression, grounded in our ever-evolving understanding of our economy. We
continue to build upon the initial consensus statement adopted in 2012 under
Chair Ben Bernanke's leadership. Today's revised statement is the outcome of
the second public review of our framework, which we conduct at five-year
intervals. This year's review included
three elements: Fed Listens events at Reserve Banks around the country, a
flagship research conference, and policymaker discussions and deliberations,
supported by staff analysis, at a series of FOMC meetings.
In
approaching this year's review, a key objective has been to make sure that our
framework is suitable across a broad range of economic conditions. At the same time, the framework needs to evolve
with changes in the structure of the economy and our understanding of those
changes. The Great Depression presented different challenges from those of the
Great Inflation and the Great Moderation, which in turn are different from the
ones we face today.
At the time of the last review, we were living in a
new normal, characterized by the proximity of interest rates to the effective
lower bound (ELB), along with low growth, low inflation, and a very flat
Phillips curve—meaning that inflation was not very responsive to slack in the
economy. To me, a statistic that captures that era is that our policy rate was
stuck at the ELB for seven long years following the onset of the Global
Financial Crisis (GFC) in late 2008.
Many here will recall the sluggish growth and
painfully slow recovery of that era. It appeared highly likely that if the
economy experienced even a mild downturn, our policy rate would be back at the
ELB very quickly, probably for another extended period. Inflation and inflation
expectations could then decline in a weak economy, raising real interest rates
as nominal rates were pinned near zero. Higher real rates would further weigh
on job growth and reinforce the downward pressure on inflation and inflation
expectations, triggering an adverse dynamic.
The economic conditions that brought the policy
rate to the ELB and drove the 2020 framework changes were thought to be rooted
in slow-moving global factors that would persist for an extended period—and
might well have done so, if not for the pandemic. The 2020 consensus statement
included several features that addressed the ELB-related risks that had become
increasingly prominent over the preceding two decades. We emphasized the
importance of anchored longer-term inflation expectations to support both our
price-stability and maximum-employment goals.
Drawing on
an extensive literature on strategies to mitigate risks associated with the
ELB, we adopted flexible average inflation targeting—a "makeup"
strategy to ensure that inflation expectations would remain well anchored even
with the ELB constraint. In particular, we said that, following periods when
inflation had been running persistently below 2 percent, appropriate monetary
policy would likely aim to achieve inflation moderately above 2 percent for
some time.”
In the event, rather than low inflation and the
ELB, the post-pandemic reopening brought the highest inflation in 40 years to
economies around the world. Like most other central banks and private-sector
analysts, through year-end 2021, we thought that inflation would subside fairly
quickly without a sharp tightening in our policy stance. When it became clear
that this was not the case, we responded forcefully, raising our policy rate by
5.25 percentage points over 16 months. That action, combined with the unwinding
of pandemic supply disruptions, contributed to inflation moving much closer to
our target without the painful rise in unemployment that has accompanied
previous efforts to counter high inflation.
Elements of
the Revised Consensus Statement and analysis
This year's review considered how economic
conditions have evolved over the past five years. During this period, we saw
that the inflation situation can change rapidly in the face of large shocks. In
addition, interest rates are now substantially higher than they case during the
era between the GFC and the pandemic. With inflation above target, our policy
rate is restrictive—modestly so, in my view. We cannot say for certain where
rates will settle out over the longer run, but their neutral level may now be
higher than during the 2010s, reflecting changes in productivity, demographics,
fiscal policy, and other factors that affect the balance between saving and
investment.
During the review, we discussed how the 2020
statement's focus on the ELB may have complicated communications about our
response to high inflation. We concluded that the emphasis on an overly
specific set of economic conditions may have led to some confusion, and, as a
result, we made several important changes to the consensus statement to reflect
that insight.
First, we removed language indicating that the ELB
was a defining feature of the economic landscape. Instead, we noted that our
"monetary policy strategy is designed to promote maximum employment and
stable prices across a broad range of economic conditions." The difficulty
of operating near the ELB remains a potential concern, but it is not our
primary focus. The revised statement reiterates that the Committee is prepared
to use its full range of tools to achieve its maximum-employment and
price-stability goals, particularly if the federal funds rate is constrained by
the ELB.”
Second, we returned to a framework of flexible
inflation targeting and eliminated the "makeup" strategy. As it
turned out, the idea of an intentional, moderate inflation overshoot had proved
irrelevant. There was nothing intentional or moderate about the inflation that
arrived a few months after we announced our 2020 changes to the consensus
statement, as I acknowledged publicly in 2021.
Well-anchored inflation expectations were critical
to our success in bringing down inflation without a sharp increase in
unemployment. Anchored expectations
promote the return of inflation to target when adverse shocks drive inflation
higher, and limit the risk of deflation when the economy weakens. Further, they
allow monetary policy to support maximum employment in economic downturns
without compromising price stability.
Our revised statement emphasizes our commitment to
act forcefully to ensure that longer-term inflation expectations remain well
anchored, to the benefit of both sides of our dual mandate. It also notes that
"price stability is essential for a sound and stable economy and supports
the well-being of all Americans." This theme came through loud and clear
at our Fed Listens events. The past five years have been a painful reminder of
the hardship that high inflation imposes, especially on those least able to
meet the higher costs of necessities.
Third, our 2020 statement said that we would
mitigate "shortfalls," rather than "deviations," from
maximum employment. The use of "shortfalls" reflected the insight
that our real-time assessments of the natural rate of unemployment—and hence of
"maximum employment"—are highly uncertain. The later years of the
post-GFC recovery featured employment running for an extended period above mainstream
estimates of its sustainable level, along with inflation running persistently
below our 2 percent target. In the absence of inflationary pressures, it might
not be necessary to tighten policy based solely on uncertain real-time
estimates of the natural rate of unemployment.
We still have that view, but our use of the term
"shortfalls" was not always interpreted as intended, raising
communications challenges. In particular, the use of "shortfalls" was
not intended as a commitment to permanently forswear preemption or to ignore
labor market tightness. Accordingly, we removed "shortfalls" from our
statement. Instead, the revised document now states more precisely that
"the Committee recognizes that employment may at times run above real-time
assessments of maximum employment without necessarily creating risks to price
stability." Of course, preemptive action would likely be warranted if
tightness in the labor market or other factors pose risks to price stability.
The revised statement also notes that maximum
employment is "the highest level of employment that can be achieved on a
sustained basis in a context of price stability." This focus on promoting
a strong labor market underscores the principle that "durably achieving
maximum employment fosters broad-based economic opportunities and benefits for
all Americans." The feedback we received at Fed Listens events reinforced
the value of a strong labor market for American households, employers, and
communities.
Fourth, consistent with the removal of "shortfalls,"
we made changes to clarify our approach in periods when our employment and
inflation objectives are not complementary.
In those circumstances, we will follow a balanced approach in promoting them.
The revised statement now more closely aligns with the original 2012 language.
We take into account the extent of departures from our goals and the
potentially different time horizons over which each is projected to return to a
level consistent with our dual mandate. These principles guide our policy decisions
today, as they did over the 2022–24 period, when the departure from our 2
percent inflation target was the overriding concern.
In addition to these changes, there is a great deal
of continuity with past statements. The document continues to explain how we
interpret the mandate Congress has given us and describes the policy framework
that we believe will best promote maximum employment and price stability. We
continue to believe that monetary policy must be forward-looking and consider
the lags in its effects on the economy. For this reason, our policy actions
depend on the economic outlook and the balance of risks to that outlook. We
continue to believe that setting a numerical goal for employment is unwise,
because the maximum level of employment is not directly measurable and changes
over time for reasons unrelated to monetary policy.
We also continue to view a longer-run inflation
rate of 2 percent as most consistent with our dual-mandate goals. We believe that our commitment to
this target is a key factor in helping keep longer-term inflation expectations
well anchored. Experience has shown that 2 percent inflation is low enough to
ensure that inflation is not a concern in household and business decision-making
while also providing a central bank with some policy flexibility to provide
accommodation during economic downturns.
Finally, the revised consensus statement retained
our commitment to conduct a public review roughly every five years. There is
nothing magic about a five-year pace. That frequency allows policymakers to
reassess structural features of the economy and to engage with the public,
practitioners, and academics on the performance of our framework. It is also
consistent with several global peers.”
Full Text of Fed’s Statement on
Longer-Run Goals and Monetary Policy Strategy
Adopted effective January 24, 2012; as
amended effective August 22, 2025
“The
Federal Open Market Committee (FOMC) is firmly committed to fulfilling its
statutory mandate from Congress of promoting maximum employment, stable prices,
and moderate long-term interest rates.
The Committee seeks to explain its monetary policy decisions to the public as
clearly as possible. Such clarity facilitates well-informed decision-making by households
and businesses, reduces economic and financial uncertainty, increases the
effectiveness of monetary policy, and enhances transparency and accountability,
which are essential in a democratic society.
The
Committee’s monetary policy strategy is designed to promote maximum employment
and stable prices across a broad range of economic conditions. Employment,
inflation, and long-term interest rates fluctuate over time in response to
economic and financial disturbances. Monetary policy plays an important role in
stabilizing the economy in response to these disturbances. The Committee’s
primary means of adjusting the stance of monetary policy is through changes in
the target range for the federal funds rate. The Committee is prepared to use
its full range of tools to achieve its maximum employment and price stability
goals, particularly if the federal funds rate is constrained by its effective
lower bound.
Durably
achieving maximum employment fosters broad-based economic opportunities and
benefits for all Americans. The Committee views maximum employment as the
highest level of employment that can be achieved on a sustained basis in a
context of price stability. The maximum level of employment is not directly
measurable and changes over time owing largely to nonmonetary factors that
affect the structure and dynamics of the labor market. Consequently, it would
not be appropriate to specify a fixed goal for employment; rather, the
Committee’s policy decisions must be informed by assessments of the maximum level
of employment, recognizing that such assessments are necessarily uncertain and
subject to revision. The Committee considers a wide range of indicators in
making these assessments.
Price
stability is essential for a sound and stable economy and supports the
well-being of all Americans. The inflation rate over the longer run is
primarily determined by monetary policy, and hence the Committee can specify a
longer-run goal for inflation. The Committee reaffirms its judgment that
inflation at the rate of 2 percent, as measured by the annual change in the
price index for personal consumption expenditures, is most consistent over the
longer run with the Federal Reserve’s statutory maximum employment and price
stability mandates. The Committee judges that longer-term inflation
expectations that are well anchored at 2 percent foster price stability and
moderate long-term interest rates and enhance the Committee’s ability to
promote maximum employment in the face of significant economic disturbances.
The Committee is prepared to act forcefully to ensure that longer-term
inflation expectations remain well anchored.
Monetary
policy actions tend to influence economic activity, employment, and prices with
a lag. Moreover, sustainably
achieving maximum employment and price stability depends on a stable financial
system. Therefore, the Committee’s policy decisions reflect its longer-run
goals, its medium-term outlook, and its assessments of the balance of risks,
including risks to the financial system that could impede the attainment of the
Committee’s goals.
The
Committee’s employment and inflation objectives are generally complementary.
However, if the Committee judges that the objectives are not complementary, it
follows a balanced approach in promoting them, taking into account the extent
of departures from its goals and the potentially different time horizons over
which employment and inflation are projected to return to levels judged
consistent with its mandate. The Committee recognizes that employment may at
times run above real-time assessments of maximum employment without necessarily
creating risks to price stability.
The
Committee intends to review these principles and to make adjustments as
appropriate at its annual organizational meeting each January, and to undertake
roughly every 5 years a thorough public review of its monetary policy strategy,
tools, and communication practices.”
Summary of FOMC Statement on
Longer-Run Goals and Monetary Policy Strategy, adopted on January 24, 2012, and
amended on August 22, 2025:
·
Statutory Mandate: The FOMC is committed to
promoting maximum employment, stable prices, and moderate long-term interest
rates, as mandated by Congress.
·
Transparency and Communication: The
Committee emphasizes clear communication to enhance public understanding,
reduce economic uncertainty, and increase monetary policy effectiveness,
transparency, and accountability.
·
Monetary Policy Tools: The primary tool for
adjusting monetary policy is changing the target range for the federal funds
rate. The FOMC is prepared to use its full range of tools, especially when the
federal funds rate is near its effective lower bound (ELB), to achieve its
goals.
Maximum Employment: Fed is open to moving
its goal post as per evolving economic conditions
·
Defined as the highest sustainable level of
employment consistent with price stability.
·
Not directly measurable and influenced by
nonmonetary factors affecting the labor market.
·
No fixed employment goal is set; the
Committee uses a wide range of indicators and revises assessments as needed.
·
Achieving maximum employment fosters
broad-based economic opportunities.
Price Stability: 2% PCE inflation
target remains sacrosanct
·
The FOMC targets a 2 percent inflation rate
(measured by the annual change in the Personal Consumption Expenditures price
index) as the longer-run goal, consistent with its mandate.
·
Well-anchored inflation expectations at 2
percent support price stability, moderate long-term interest rates, and maximum
employment.
·
The Committee is prepared to act forcefully
to maintain anchored inflation expectations.
Policy Approach:
·
Monetary policy actions influence the
economy with a lag and require a stable financial system.
·
Decisions reflect longer-run goals,
medium-term outlooks, and risk assessments, including risks to the financial
system.
·
Employment and inflation goals are
generally complementary, but if they conflict, the FOMC adopts a balanced
approach, considering deviations from goals and time horizons for achieving
them.
·
Employment may exceed real-time maximum
employment estimates without necessarily risking price stability.
Points to be noted:
·
Fed will not go
back to ELB (Effective lower bound rate) or near-zero interest rate policy in a
hurry as a standard procedure even in the event of the next financial crisis
like 2008 GFC, 2020 COVID, as the subsequent higher inflation and higher real
interest rate causes higher unemployment and lower inflation, i.e., deflationary-like
situation, triggering an adverse dynamic.
·
Previously, the Fed
was focused more on anchoring longer-term inflation expectations in the era of
a financial crisis rather than actual inflation.
·
Previously, the Fed
adopted flexible average inflation targeting- a "makeup" strategy to
ensure that inflation expectations would remain well anchored even with the ELB
constraint.
·
The focus will now
be on 2% flexible inflation targeting along with well-anchored longer-term
inflation expectations around 2% and actual longer-term inflation of 2.0%
·
Although the Fed
initially made a policy mistake by judging higher inflation post-COVID as
transitory, the Fed rectified itself and hiked rates quite aggressively. This
caused the economy to run relatively slowly and coupled with the easing of
post-COVID supply chain disruptions and withdrawal of COVID-era fiscal
stimulus, resulted in lower inflation
without causing a hard landing.
·
Fed may now keep
the longer run terminal/neutral rate around 3.00% (as per the latest Fed
Dot-Plots) against the pre-COVID level of 2.50%
·
Fed may keep the
neutral rate comparatively higher due to changing productivity, demographics,
fiscal policies and certain other factors that affect the balance between
saving and investment
·
The focus would now
be on flexible inflation and employment targeting across a broad range of
economic conditions, with all available tools rather than focusing too much on the
ELB constraint to ensure minimum price stability and maximum employment.
·
Fed will target
flexible maximum employment as per evolving economic situations, and even allow
a tighter labor market unless it causes a real increase in inflation.
·
The Fed will not
tighten solely based on higher levels of employment
·
In the event of
higher than targeted inflation or unemployment rate, the Fed will consider both
quantitatively and take appropriate policy actions to return to the target in
the shortest period of time possible
·
Fed will
continue to take policy action based on forward forward-looking economic
outlook and the balance of risks to that outlook
·
Fed will be
flexible in its maximum employment target as per actual economic conditions and
evolving economic outlook
·
Although the Fed
may be flexible in short-term inflation targeting as per actual economic
conditions, the longer-run inflation target of 2.0% remains sacrosanct
Key
Principles
·
Dual Mandate:
Promote maximum employment and 2% inflation (PCE price index)
·
Flexible
Inflation Targeting: Maintain well-anchored inflation expectations at 2%, abandoning
the 2020 makeup strategy.
·
Maximum
Employment: Tolerate employment above real-time estimates unless it risks price
stability; no fixed employment goal due to non-monetary factors
·
Balanced
Approach: When goals conflict, weigh deviations and time horizons for returning
to targets
·
Forward-Looking:
Policy decisions based on economic outlook, risk assessments, and lagged
effects
·
Current Stance:
Modestly restrictive federal funds rate; inflation near 2%
·
Neutral Rate:
Potentially higher than pre-pandemic levels due to productivity, demographics,
and fiscal policy changes
·
Phillips Curve:
Flatter, allowing strong labor markets without immediate inflationary pressure
Likely
Policy Actions
·
Data-Dependent:
Adjust federal funds rate based on inflation, employment, and risk indicators
·
Easing: Possible
if inflation stabilizes at 2% and growth slows
·
Tightening:
Likely if inflation exceeds 2% due to shocks or labor market tightness
·
ELB
Preparedness: Ready to use the full range of tools if rates approach the effective
lower bound
Summary:
·
Flexible inflation and employment targeting in the
shorter term without taking aggressive policy actions on both sides
(tightening/softening)
·
The Fed will
maintain a flexible, data-driven approach, prioritizing 2% inflation
expectations while supporting strong employment. Preemptive action will be
taken if inflationary risks emerge, with a balanced response to trade-offs.
Analysis
The post-GFC era (pre-2020) was marked by low
growth, low inflation, a flat Phillips Curve, and prolonged periods at the ELB,
raising concerns about deflationary pressures and high real interest rates in
downturns. The post-pandemic (COVID) period brought higher inflation (the
highest in 40 years), driven by supply shocks and reopening dynamics, necessitating
a rapid 5.25% increase in the federal funds/repo rate over 16 months
(2022–2023). This action, combined with easing of supply disruptions, brought
inflation closer to 2% without a significant unemployment spike, highlighting
the role of anchored inflation expectations. Fast forward, current economic conditions
(as of August 2025) show the policy rate in restrictive territory (described as
“modestly” restrictive by Powell), with a potentially higher neutral rate than
in the 2010s due to changes in productivity, demographics, fiscal policy, and
savings-investment balances.
Rationale
for Framework Changes:
The 2020 FAIT and makeup strategy was designed for
ELB constraints and low inflation, but proved less relevant during high
inflation. The focus on ELB risks complicated communication during the
2021–2022 inflation surges, prompting the shift to flexible inflation
targeting. The removal of “shortfalls” language clarifies that the Fed is not
committed to ignoring labor market tightness or forswearing preemption. This
allows for proactive tightening if inflationary risks arise, even if
unemployment is low. The emphasis on anchored inflation expectations reflects
lessons from the post-pandemic period, where expectations helped stabilize
inflation without severe unemployment costs.
Policy
Implications:
Powell highlights the Fed’s success in reducing
inflation without a sharp unemployment increase, suggesting confidence in a data-driven,
flexible approach. The revised framework prioritizes adaptability to rapid
changes (e.g., inflation shocks) and a strong labor market, provided price
stability is maintained. The acknowledgment of a potentially higher neutral
rate suggests the Fed anticipates maintaining higher interest rates than in the
pre-pandemic era, though the exact level remains uncertain.
Public
Engagement: Wall Street and Main Street
Feedback from Fed Listens events underscores the
public’s sensitivity to high inflation’s impact on necessities and the value of
a strong labor market. This reinforces the Fed’s commitment to balancing both
mandates while prioritizing price stability when inflation deviates
significantly.
Likely
Policy Approach: Combining
insights from the FOMC statement and Powell’s speech, the Federal Reserve’s
likely policy approach in the near term (as of August 2025) can be outlined as
follows:
·
Data-Dependent and Flexible: The Fed will continue to rely on a broad range of
indicators (e.g., labor market data, inflation measures, economic projections)
to guide policy decisions. The forward-looking nature of policy, as emphasized
by Powell and the FOMC document, means the Fed will adjust the federal funds
rate based on incoming data and risk assessments.
·
Prioritizing Anchored Inflation Expectations: The Fed will act decisively to maintain inflation
expectations at 2%, as this supports both price stability and maximum
employment. If inflation risks rise significantly (e.g., due to supply shocks
or labor market tightness), the Fed is likely to tighten policy preemptively,
as indicated by the removal of “shortfalls” language and the emphasis on
preemptive action when needed.
·
Tolerating Strong Labor Markets: The Fed will allow employment to run above
real-time estimates of maximum employment unless it clearly threatens price
stability. This reflects the revised statement’s recognition that high
employment does not always lead to inflationary pressures, especially with a
flatter Phillips Curve.
·
Balanced Approach to Trade-Offs: When inflation and employment goals conflict, the
Fed will weigh deviations from both targets and their respective time horizons.
The 2022–2024 period, where inflation was the primary concern, suggests the Fed
will prioritize price stability during significant inflationary pressures but
aim to avoid unnecessary unemployment spikes.
·
Higher Neutral Rate Considerations: With the neutral rate potentially higher than in
the 2010s, the Fed may maintain a modestly restrictive stance longer than in the
pre-pandemic era. However, Powell’s description of the current rate as
“modestly restrictive” suggests openness to easing if inflation continues to
align with the 2% target and economic growth slows.
·
·
Preparedness for ELB: While the ELB is no longer the primary focus, the
Fed remains prepared to use its full range of tools (e.g., forward guidance,
quantitative easing) if rates approach the ELB in a downturn, ensuring
flexibility across economic conditions.
Economic Context
and Policy Implications
·
Current
Conditions (August 2025): Inflation is close to 2%, and the policy rate is
modestly restrictive. The labor market appears strong, but the Fed is vigilant
about potential inflationary pressures from tightness or external shocks.
·
Phillips Curve
Influence: The flatter Phillips Curve noted by Powell suggests that
unemployment can remain low without triggering significant inflation,
supporting the Fed’s tolerance for strong labor markets. However, the Fed will
monitor wage growth and other indicators for signs of inflationary pressure.
·
Recent Policy
Success: The 2022–2023 tightening cycle’s success in reducing inflation without
a sharp unemployment increase bolsters the Fed’s confidence in its data-driven
approach and the importance of anchored expectations.
Potential
Scenarios
·
Easing Scenario:
If inflation stabilizes at 2% and economic growth slows (e.g., due to global
factors or domestic demand weakening), the Fed may gradually lower the federal
funds rate to a less restrictive level, closer to the neutral rate, to support
employment.
·
Tightening
Scenario: If inflation rises above 2% (e.g., due to new supply shocks or
persistent labor market tightness), the Fed is likely to raise rates or
maintain a restrictive stance, acting preemptively to anchor expectations.
·
Neutral
Scenario: If inflation remains near 2% and employment stays strong without
overheating, the Fed may hold rates steady, adjusting only as new data emerges.
The Federal Reserve’s likely policy approach, as
indicated by the revised FOMC policy strategy and Powell’s Jackson Hole speech,
is a data-dependent, flexible inflation & employment targeting regime that
prioritizes maintaining inflation expectations at 2% while fostering a strong
labor market. The Fed will tolerate employment above real-time maximum
estimates unless it risks price stability, reflecting a nuanced view of the
Phillips Curve. With a potentially higher neutral rate, the Fed may maintain
modestly restrictive rates in the near term but is prepared to ease or tighten
based on economic indicators. When trade-offs arise, the Fed will adopt a
balanced approach, weighing deviations from its dual mandate goals and their
time horizons. This framework ensures adaptability to a broad range of economic
conditions, with a commitment to act decisively to prevent unanchored inflation
expectations or significant economic downturns.
Conclusions:
Looking ahead, from 2026 onwards. Fed may
officially/unofficially keep a flexible inflation and employment targeting
mechanism. At present, although officially the Fed’s inflation target is 2.0%
core PCE inflation, in reality it’s 1.6%, which is equivalent to 2.3% core CPI
inflation; the average of both is around 2.0% core inflation (as per the pre-COVID-19
2019 trend). Fed maintained 2.3% core CPI inflation, 1.5% core PCE inflation,
3.6% unemployment rate against 1.75% repo rate at December 2019 (after repo/QT)
AND Trump/US-China trade war 1.0 tantrum; the repo rate was 2.50% till H1CY19.
At that time Fed largely kept a 0.50% real repo rate (repo rate-core CPI)
against 2.00% core CPI inflation and a 3.7% unemployment rate on average.
Now Fed may keep a 2.0%-3.0% flexible inflation
(core CPI) target as price stability against 3.5%-4.5% flexible unemployment
targets and +1.00% neutral or real interest rate (wrt core CPI). Now, in 2025,
the average core CPI inflation may stay around 3.00%, the average unemployment
rate 4.3%, while the Fed may cut 25 bps each in September and December’25,
giving priority to the employment mandate. But in 2026, if US core CPI inflation
really surges to around 3.5% on average (as per the present trend) due to Trump
policy tantrum, while US unemployment rate remains around 4.0%, the Fed may not
cut rates in 2026.
Fed may maintain +1.0% real repo rate or real
interest wrt average core CPI inflation. By December 2025, the Fed may cut 50
bps cumulative to a 4.0% repo rate against the estimated 3.0% average core CPI
inflation. Looking forward, the average core CPI inflation should be around
3.5% and the unemployment rate 4.3% by December 2026. Against this, the Fed may
continue to hold the repo rate at 4.0%, resulting in a real REPO rate as both
inflation and unemployment are at upper bounds.
The average US core CPI inflation for 2025 (Till
July) was around 3.0% against 3.4% in 2024 and 2.3% in 2019. Fed’s actual
target for price stability is 1.6% core PCE, which is equivalent to 2.3% core
CPI, and the average of both is 2.0% core inflation (PCE+CPI). Overall, the
present level of inflation is still above 70 bps from the Fed’s target with an
upward risk. The 2024 average US unemployment rate was 4.0%, and 2025 (till
July) was 4.2%, higher than the pre-COVID 2019 average unemployment rate of 3.7%;
i.e., 50 bps higher than maximum employment levels, with an upward risk and
also above the Fed’s standard 4.0%, but still lower than the 4.5%-5.0% red line
zone. Thus Fed needs to bring down both US core inflation by around 70 bps and
the unemployment rate by around 60 bps from expected 2025 average levels of
3.0% (core inflation) and 4.3% (unemployment rate) by 2027.
Thus, to balance the dual mandate of 2.0% minimum
price stability (average core inflation-PCE+CPI) and 3.7% maximum unemployment,
the Fed may cut 25 bps each in September and December 2025, followed by a long
pause in H1CY26 and then again cut another 50/25 bps in H2CY26. Fed has to take
calibrated monetary policy actions to balance both sides of its mandate to
bring the unemployment rate below 4% and core inflation average 2.5% by 2026,
and then further bring down the unemployment rate to 3.7% and core inflation to
2.0% by 2027. Fed has to act carefully to ensure a soft landing and no
stagflation-like scenario for the US economy (higher inflation, higher
unemployment rate and lower economic growth).
Fed may cut 25 bps each in September and December
2025, followed by a long pause again in H1CY26 and then cut another 25 bps in
September’26, if average US core CPI inflation rises to around 3.50% in 2026
from 3.00% in 2025 due to Trump’s policies. And the Fed may not cut rates at
all in 2026 if US core CPI inflation really surges towards 3.50% average in 2026.
Then, if US core CPI inflation really comes down
towards 3.00% and 2.30% in 2027 and 2028 (assuming transitory Trumpflation),
the Fed may cut 50 bps in 2027 and 25 bps in 2028 for a longer run terminal
rate of 3.00% against pre-COVID levels of 2.50%. Fed may keep the longer run
neutral rate around 1.00% against 0.50% in pre-COVID times, assuming lower US
productivity and higher inflation dynamics. If US core CPI inflation does not
surge in 2026 towards a 3.50% average rate, then the Fed may cut 50 bps also in
2026, followed by another 50 bps in 2027 for a terminal rate of 3.00% by 2027
(in line with June’25 dot-plots).
As base case, Fed may cut 50 bps in H2CY25
(September and December) in line with Hune’25 dot-plots, but another 50 bps
rate cut in 2026/H2CY26 may not be certain if US core CPI inflation really
surges towards 3.50% average in 2026 from 3.00% in 2025. Fed may cut only 25
bps or even opt for no cuts in 2026 if US unemployment rate continues to hover
around 4.30% or edges down to 4.00% on average in 2026 against 3.50% core CPI
inflation. Another option (as best case)
is that the Fed may cut 100 bps in H2CY26 to front load and opt for no rate
cuts in 2026, but it would be most unlikely.
Weekly
Technical outlook: DJ-30, NQ-100, SPX-500 and Gold
Looking
ahead, whatever may be the narrative, technically Dow Future (CMP: 45700) now has to sustain over 45600-45800
for a further rally to 46400-46500 and only sustaining above 46500, may further
rally to 47100/47200 in the coming days; otherwise sustaining below
45500-45300-44900, DJ-30 may again fall to 44200/43900-43400/42400 and
41700/41200-40700/39900 in the coming days.
Similarly,
NQ-100 Future (23600) now has
to sustain over 23700 for 24000-24200* and further rally to
24300/24450-24700/25000 in the coming days; otherwise, sustaining below
24250/24000-23750/22900, NQ-100 may again fall to
22400/22200-21900/20900-20700/20200 and 19890/18300-17400/16400in the coming
days.
Looking
ahead, whatever may be the fundamental narrative, technically SPX-500 (CMP: 6550) now has to sustain over 6600 for a
further rally to 6800/7000-7500/8300 in the coming days; otherwise, sustaining
below 6575/6525-6500, may fall to 6450-6375/6300-6250/6200 and further fall to
6000/5800-5600/5300 in the coming days.
Technically
Gold (CMP: 3372) has to sustain over 3380 for a further
rally to 3405*/3425-3455/3475 to 3495/3505*, and even 3525/3555 in the coming
days; otherwise sustaining below 3375-3350, Gold may again fall to
3330/3320-3308/3290* and 3255*/3225*-3200/3165* and further to
3130/3115*-3075/3015-2990/2975-2960*/2900* and 2800/2750 in the coming days.
Disclaimer: I
am an NSE-certified Level-2 market professional (Financial Analyst- Fundamental
+ Technical) and not a SEBI/SEC-registered investment advisor. The article is
purely educational and not a proxy for any trading/investment
signal/advice. I am a professional
analyst, signal provider, and content writer with over ten years of experience.
All views expressed in the blog are strictly personal and may not align with
any organization with, I may be associated.
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