The Federal Reserve may have limited room for interest rate cuts in the short term, with long-term low inflation being the core goal

According to the Zhitong Finance APP, after Federal Reserve Chairman Jerome Powell released dovish signals at the Jackson Hole Global Central Bank Annual Meeting, financial markets have warmed to the expectation that the Federal Reserve will cut interest rates at its policy meeting on September 16-17. As of the time of writing, the CME's "FedWatch Tool" shows that the probability of a rate cut in September has reached 89.7%.

However, the nearly 10% probability of no rate cut is also noteworthy. Although it has significantly retreated from its peak in 2022, the inflation indicator favored by the Federal Reserve—the core PCE price index—remains above its 2% target level. This strongly supports the view that there may be no rate cut in September, or even throughout the year.

Inflation Still Above Target

Tariffs complicate the calculation of inflation. Past research by the Federal Reserve has concluded that it is best to ignore price changes caused by tariffs. These are typically one-time price level increases that do not drive higher inflation year after year. A rough estimate can start from the inflation level before President Trump took office: 2.9%, which fluctuated between 2.6% and 3.1% in the previous year. It is stable but above target.

As of now, the seven inflation readings for 2025 are all in the range of 2.6%-2.9%. On the surface, inflation seems unchanged. Calculations based on tariff revenues indicate that if tariffs are fully passed on to consumers, prices may have recently risen by 0.6%. While it is highly likely that tariffs will be fully transmitted in the long term, it is extremely unlikely in the short term. Sellers may have reduced prices by about half of the tariff increase (but this will not last long).

At the September policy meeting, Federal Reserve officials advocating for a rate cut may argue that if tariffs and the depreciation of the dollar are considered, core inflation is declining. Although inflation remains above target regardless of the calculation method, it may be moving in the right direction. Federal Reserve economists are conducting more detailed calculations to arrive at their own core inflation estimates.

Labor Market Remains Robust

Over the past 12 months, the unemployment rate in the United States has remained largely stable, with the latest data at 4.2%. In 2022 and 2023, it once dropped to 3.4%, a level generally considered unsustainable. The unemployment rate can never be zero, as job seekers and employers need time to find suitable matches. The natural unemployment rate estimated by the Congressional Budget Office (CBO) is 4.3%, which is the unemployment rate caused by all factors other than overall demand fluctuations. The CBO also estimates the potential GDP level. Actual GDP is less than 1% below the potential level, a remarkably small gap.

Economists typically focus on new job creation, but due to the currently very low immigration levels, this metric has become an ineffective tool for measuring economic performance. Although layoffs have attracted some media attention, the number of people applying for unemployment insurance is unusually low. The number of voluntary resignations and layoffs is flat, with hiring slightly decliningAll labor market data indicates that the current economic conditions are good, far from proving the need to loosen monetary policy. However, the Federal Reserve believes that current interest rates are restrictive, and without action, the economy will slow down.

Economic forecasts are the best reason for rate cuts

Most economists expect the unemployment rate to rise. A survey of professional forecasters conducted by the Philadelphia Fed predicts that the unemployment rate will rise to 4.5% by mid-2026. This is by no means a concerning level, but a slight rate cut may be appropriate. A 25 basis point rate cut has limited effects on the economy, but a series of cuts could have a greater impact.

Why the Federal Reserve is so focused on inflation

Many wonder why the Federal Reserve is so focused on inflation. In the short term, the labor market seems more important than the inflation rate. However, economists study the long-term effects of different policies. Suppose one completely disregards inflation and only pursues a good labor market—where those who want to work can find jobs, and layoffs are minimal. What kind of economic environment can create such a labor market?

The answer is that low and stable inflation leads to low and stable unemployment. This conclusion is based on multiple studies, including the history of the U.S. economy and experiences from other countries. In the short term, there may be a trade-off between inflation and unemployment, but there is none in the long term. When pursuing low and stable inflation, one can also achieve low and stable unemployment.

Given the uncertainty in economic forecasts, there may be opposition to rate cuts at the Federal Reserve's September policy meeting, based on the points mentioned above, as well as a more fundamental reason—low inflation is crucial for a healthy labor market