Last month, the Federal Reserve held interest rates steady for its fifth straight meeting, partly citing what has become a fairly well-trod reason: uncertainty around President Donald Trump’s tariffs.
In leaving borrowing costs unchanged at a range of 4.25% to 4.5%, policymakers at the U.S. central bank agreed, albeit with some larger-than-usual dissent, that the "wait-and-see" approach was prudent as more clarity emerges around the effect of Trump’s levies.
The Fed, whose two-pronged mandate revolves around both inflation and employment, faces a dilemma. Recent data has suggested that the tariffs are beginning to feed into price growth in levy-exposed goods, bolstering the case for rates to stay higher for longer.
"What remains unclear is how much inflation will rise, for how long, and whether tariff inflation spills over into broader inflation measures," analysts at Morgan Stanley said in a note.
But, at the same time, the jobs picture appears to be deteriorating, with July’s nonfarm payrolls report coming in well below expectations. The previous two months were also sharply revised downward, pouring cold water on initial hopes that the labor market could weather Trump’s flurry of tariffs, while the unemployment rate also edged higher.
Slower job growth, in theory, could be a case for cutting rates -- and were used as evidence by the two dissenting Fed members at the central bank’s latest gathering. Fed Governors Christopher Waller and Michelle Bowman both argued for a drawdown, with jobs market concerns front of mind. On balance, between price gains and weak job additions, inflation is "the bigger problem through the end of the year" for the Fed, the Morgan Stanley analysts argued. For that reason, unlike many other brokerages on Wall Street, they do not expect the Fed to cut interest rates this year.
"Slower labor demand suggests downside risks, but inflation is above target and rising," the Morgan Stanley analysts led by Seth Carpenter wrote.
Still, tariff developments and the weak jobs report have fueled an uptick in investor bets that the Fed will reduce rates as soon as its next meeting in September. Markets are assigning roughly 88% odds of a September rate cut, according to the {CME FedWatch Tool}.
