Inflation vs. Growth : Is the Fed Behind or Ahead of the Curve?CME_MINI:NQ1! CME_MINI:ES1! CME_MINI:MNQ1! CME_MINI:MES1! CBOT:ZN1!
Fed Policy recap:
There is an interesting and unusual theme to keep an eye on this week. The Fed is in a ‘blackout period’ until the FOMC meeting- this is a customary quiet period ahead of an FOMC policy meeting. Fed Chair Powell is scheduled to give a public talk on Tuesday. Although his address will be focused on the capital framework of the large banks, this appearance will be closely watched for any subtle signals on the FOMC policy stance.
Especially given that last week, Federal Reserve Governor Chris Waller made a speech, “The Case for Cutting Now” with a purpose as he stated to explain why the FOMC should reduce rate by 25 bps at the July 30th, 2025 meeting.
His stated reasons were:
1. Tariffs create one-off price level increases with transitory inflation effects, not sustained inflation momentum.
2. He argued that much of economic data points towards interest rates should be lowered to FOMC’s participants' median neutral rate, i.e, 3%.
3. His third stated reason notes that while the state of the labor market looks resilient on the surface, accounting for expected data revisions, private-sector payroll growth has peaked, with more data suggesting increased downside risks.
His speech further explains:
• Growth has decelerated sharply: Real GDP rose only ~1% annualized in 1H25, a significant slowdown from 2.8% in 2H24, and well below long-run potential.
• Consumer spending is weakening, with real PCE growth falling to ~1%, and June retail sales showing soft underlying momentum.
• Broader labor market indicators, including the Beige Book and JOLTS data, show declining labor demand and hiring caution, suggesting increasing downside risks to employment.
• Inflation is slightly above target (PCE ~2.5%) but driven primarily by temporary, one-off tariff effects. Core inflation ex-tariffs is likely near 2%, and expectations remain anchored.
• Current fed funds range (4.25%–4.50%) is well above neutral (3%), implying excessive restraint.
• With inflation risks subdued and macro conditions deteriorating, a preemptive rate cut now provides optionality and avoids falling behind the curve if the slowdown deepens. Further cuts may be warranted if trends persist.
• The tax bill contains pro-growth provisions, but its economic impact is expected to be minimal in 2025.
Source: Federal Reserve Speech, The Case for Cutting Now Governor Waller
Inflation Analysis:
Let’s compare this with what we have previously mentioned regarding inflation. CPI index stood at 257.971 points in January 2020. Projecting this at a 2% Fed target, June 2025 inflation should be around 287.655 points. However, June 2025 inflation is currently at 322.56 index points, 12.2% higher above 2% the inflation trend. Effectively, this means annualized inflation since January 2020 is roughly 4.15%.
The Fed is in a real dilemma whether cutting rates given the inflation trend in the last 5 years and risks to inflation outlook justify cutting rates.
Key Questions to ask
Markets are forward looking. Investors and participants want to know:
• How will the rates impact the cost of debt service? Currently the third largest government expenditure, over $1.03 trillion.
• Will the tariff rate offset the tax revenue losses by extending tax cuts?
• Is the fiscal path sustainable?
• What happens to the long end of the yield-curve?
• Will the Fed monetize the debt issuance imbalance?
• Is this simply Governor Waller positioning himself for the next appointment of Fed Chair when Fed Chair Powell’s term expires in May 2026?
It seems there is a huge conflict between longer term implications vs quick short term fixes that align with US administration objectives.
The Week ahead:
It is a relatively light economic calendar in the US. Flash PMI readings and housing data on the docket. The primary focus as it has been for most weeks since President Trump took office, will be on the developments in trade policy and any further comments on Fed and Chair Powell. The threat of renewed tariffs starting August 1st, is also key to monitor and whether these protectionist measures will force US’s trading partners to make further concessions to negotiate trade deals.
The earnings season is off to a good start with major US banks reporting higher EPS and revenue than expectations. This week investors will be looking at Q2 earnings reports from Alphabet, Meta, Microsoft from the Mag 7 and Tesla.
