Key Takeaways

  • Federal Reserve Chair Jerome Powell on Friday paved the way for a cut in the benchmark interest rate next month, citing signs of weakness in the labor market while warning that tariffs could fuel sustained price pressures.
  • Powell said the Fed has limited room for maneuver as it seeks to curb inflation still running above its 2% target while ensuring that a slowdown in hiring since May does not morph into widespread job losses.
  • "The downside risks to employment are rising," Powell said in aspeech. "If these risks materialize, they could show up quickly in the form of a surge in layoffs and a rise in unemployment." At the same time, Powell called "the near-term risks to inflation" tilted to the upside, and said they could intensify if tariffs trigger a sustained inflation spiral.

Deeper Analysis

Powell's speech showed a markedly greater concern about the labor market than his remarks at the July 30 press conference, when policymakers voted by a majority to hold the federal funds rate in a range of 4.25% to 4.5%, with two dissents.

At that time, Powell described the labor market as "solid," citing an unusually low unemployment rate of 4.2%. According to thepolicy meeting minutesreleased Wednesday, most Fed officials then shared his assessment of the job market and expressed greater concern about persistent inflation.

However, Powell on Friday specifically highlighted the "downside" risks to employment. He noted that U.S. nonfarm payrolls grew by an average of just 35,000 per month from May through July, compared with an average monthly gain of 168,000 last year.

"This slowdown is much larger than assessed a month ago," Powell said, noting that policymakers did not have the full picture of labor market weakness since May when they held borrowing costs steady on July 30.

Powell also noted that both the supply of and demand for labor are declining: stricter immigration policies have tightened the labor pool, while businesses are reducing hiring due to uncertainty over the Trump administration's policies on regulation, trade, fiscal matters, and other areas. This unusual pattern on both sides of supply and demand means employment risks are rising.

"Given that (monetary) policy is in restrictive territory, the baseline outlook and the shift in the balance of risks may call for us to adjust our policy stance," he said.

Powell's remarks prompted interest rate futures traders to increase bets on policy easing next month. According to theCME FedWatch tool, market expectations for a 25-basis-point rate cut at the two-day meeting ending September 17 rose to 85.2% from 75% on Thursday.

Economists at BofA Securities said in a report that Powell was "more dovish than we and the market expected." "Now, the burden of preventing a September rate cut clearly falls on the data."

They added: "Powell was clearly shaken by the downward revisions to nonfarm payrolls, as there have been no other major dovish developments since his hawkish press conference in July." This refers to the downward revisions to May and June hiring data this month.

While focusing on the cooling labor market, Powell did not downplay the risk of rising inflation. He noted that policymakers face "a challenging situation," having to contend with both the prospect of higher inflation and the "downside" risks to employment.

Based on recent data, the personal consumption expenditures (PCE) price index, excluding volatile food and energy prices, likely rose 2.9% year-over-year last month, well above the Fed's 2% longer-run target. Policymakers prefer to use the PCE gauge to track price pressures.

"The effects of tariffs on consumer prices are now clearly visible," Powell said. "We expect these effects to accumulate over the coming months, but the timing and magnitude are highly uncertain."

"For monetary policy, the key question is whether these price increases could significantly heighten the risk of a persistent inflation problem," Powell said.

The impact of import tariffs could be relatively transitory—a one-time jump in prices—but he also warned that it takes time for tariff costs to pass through supply chains and distribution networks.

"However, it is also possible that the upward price pressures from tariffs could trigger more persistent inflation dynamics, a risk that needs to be assessed and managed," Powell said.